SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number: 0-20960
HAMILTON BANCORP INC.
(Exact Name of Registrant as Specified in Its Charter)
FLORIDA 65-0149935
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
3750 N.W. 87TH AVENUE, MIAMI, FLORIDA 33178
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (305) 717 - 5500
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Indicate by check v whether the registrant: (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No []
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15 (d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes [ ] No []
INDEPENDENT AUDITORS' REPORT
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We have reviewed the accompanying consolidated statements of condition of
Hamilton Bancorp Inc. and Subsidiaries (the "Company") as of September 30, 2001,
and the related consolidated statements of operations for the three and nine
month periods then ended and the related consolidated statements of
comprehensive income, stockholders' equity and cash flows for the nine month
period then ended. These financial statements are the responsibility of the
Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with auditing standards generally accepted in the United States, the objective
of which is the expression of an opinion regarding the financial statements
taken as whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying consolidated financial statements for it to be in
conformity with accounting principles generally accepted in the United States.
As more fully discussed in Note 2, the Office of the Comptroller of the Currency
("OCC") is currently in the final stages of conducting a safety and soundness
examination of Hamilton Bank, N.A. (the "Bank"). In connection with this
examination, the OCC orally advised the Bank of preliminary findings that the
Bank may need to increase its allowance for loan losses reported in the Bank's
Call Report as of June 30, 2001 by up to $11 million. Should the Bank be
required to amend its June 30, 2001 Call Report as previously mentioned, the
Company will also amend its consolidated financial statements included in Form
10-Q for the quarters ended June 30 and September 30, 2001. The estimated effect
of any such adjustment would be to increase the consolidated net loss reported
for the quarter ended June 30, 2001 by up to $11 million, from $24.7 million
($2.45 per share) to $35.7 million ($3.54 per share). The net loss for the
quarter ended September 30, 2001 of $6.2 million ($.61 per share) would change
to an estimated net income of $5 million ($.50 per share).
The accompanying consolidated financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business. In addition to the above, the
Bank is currently subject to considerable regulatory actions, as more fully
disclosed in Note 2. The resolution of these matters as well as the uncertainty
of what specific actions the regulators might take raise substantial doubt about
the Company's ability to continue as a going concern. The consolidated financial
statements do not include the adjustments, if any, that might have been required
had the outcome of the above mentioned uncertainties been known, or any
adjustments relating to the recoverability of recorded asset amounts or the
amounts of liabilities that may be necessary should the Company be unable to
continue as a going concern.
KAUFMAN, ROSSIN & CO., P.A.
Miami, Florida
November 16, 2001
ITEM 1
PART I. FINANCIAL INFORMATION
HAMILTON BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION
Unaudited
(Dollars in thousands)
September 30, December 31,
------------- ------------
2001 2000
------------ ------------
ASSETS
CASH AND DEMAND DEPOSITS WITH OTHER BANKS $ 15,206 $ 125,330
FEDERAL FUNDS SOLD 38,805 4,266
----------- -----------
Total cash and cash equivalents 54,011 129,596
----------- -----------
INTEREST EARNING DEPOSITS WITH OTHER BANKS 26,375 109,989
----------- -----------
SECURITIES AVAILABLE FOR SALE 347,389 255,337
----------- -----------
LOANS-NET OF UNEARNED INCOME 957,493 1,227,880
LESS: ALLOWANCE FOR CREDIT LOSSES (51,862) (43,067)
LESS: ALLOWANCE FOR TRANSFER RISK (130) (36,607)
----------- -----------
LOANS-NET 905,501 1,148,206
----------- -----------
DUE FROM CUSTOMERS ON BANKERS ACCEPTANCES 14,880 31,544
DUE FROM CUSTOMERS ON DEFERRED PAYMENT LETTERS OF CREDIT 2,379 997
PROPERTY AND EQUIPMENT-NET 3,921 4,471
ACCRUED INTEREST RECEIVABLE 10,009 15,606
DEFERRED TAX ASSETS 30,072 22,002
GOODWILL-NET 1,518 1,483
OTHER ASSETS 15,209 22,428
----------- -----------
TOTAL $ 1,411,264 $ 1,741,659
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
DEPOSITS $ 1,298,186 $ 1,568,031
TRUST PREFERRED SECURITIES 12,650 12,650
SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE -- 14,300
BANKERS ACCEPTANCES OUTSTANDING 14,880 31,544
DEFERRED PAYMENT LETTERS OF CREDIT OUTSTANDING 2,379 997
OTHER LIABILITIES 8,347 11,642
----------- -----------
Total liabilities 1,336,442 1,639,164
----------- -----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value, 75,000,000 shares authorized, 10,081,147 shares
issued and outstanding at September 30, 2001 and December 31, 2000 101 101
Capital surplus 60,702 60,702
Retained earnings 13,807 42,151
Accumulated other comprehensive loss 212 (459)
----------- -----------
Total stockholders' equity 74,822 102,495
----------- -----------
TOTAL $ 1,411,264 $ 1,741,659
=========== ===========
See accompanying notes to consolidated financial statements.
1
HAMILTON BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands except per share data) (Unaudited)
Three Months Ended Nine Months Ended
----------------------------- -----------------------------
September 30, September 30,
----------------------------- -----------------------------
2001 2000 2001 2000
----------- ----------- ----------- -----------
INTEREST INCOME:
Loans, including fees $ 20,226 $ 29,098 $ 74,718 $ 86,035
Deposits with other banks 523 2,884 3,527 10,162
Investment securities 3,124 6,641 12,075 16,107
Federal funds sold 751 731 1,927 2,249
----------- ----------- ----------- -----------
Total 24,624 39,354 92,247 114,553
----------- ----------- ----------- -----------
INTEREST EXPENSE:
Deposits 19,801 22,341 66,059 63,608
Trust preferred securities 308 308 925 925
Federal funds purchased and securities sold under
agreements to repurchase -- 299 191 688
----------- ----------- ----------- -----------
Total 20,109 22,948 67,175 65,221
----------- ----------- ----------- -----------
NET INTEREST INCOME 4,515 16,406 25,072 49,332
PROVISION FOR CREDIT LOSSES 15,600 32,500 48,600 33,250
PROVISION FOR (RECOVERY OF) TRANSFER RISK (14,217) 4,768 (11,108) 8,379
----------- ----------- ----------- -----------
NET INTEREST INCOME (LOSS) AFTER PROVISION 3,132 (20,862) (12,420) 7,703
----------- ----------- ----------- -----------
NON-INTEREST INCOME:
Trade finance fees and commissions 1,513 1,882 4,923 6,167
Customer service fees 349 363 1,081 1,212
Net gain (loss) on securities transactions -- 1,116 (773) 3,808
Other 949 124 1,100 306
----------- ----------- ----------- -----------
Total 2,811 3,485 6,331 11,493
----------- ----------- ----------- -----------
OPERATING EXPENSES:
Employee compensation and benefits 3,800 3,514 12,088 10,132
Occupancy and equipment 1,190 1,217 3,484 3,670
Other 7,121 8,478 16,578 16,542
----------- ----------- ----------- -----------
Total 12,111 13,209 32,150 30,344
----------- ----------- ----------- -----------
LOSS BEFORE TAXES (6,168) (30,586) (38,239) (11,148)
PROVISION FOR (BENEFIT FROM) INCOME TAXES -- (12,712) (9,895) (5,811)
----------- ----------- ----------- -----------
NET LOSS $ (6,168) $ (17,874) $ (28,344) $ (5,337)
=========== =========== =========== ===========
NET LOSS PER COMMON SHARE:
BASIC AND DILUTED $ (0.61) $ (1.77) $ (2.81) $ (0.53)
=========== =========== =========== ===========
AVERAGE SHARES OUTSTANDING:
BASIC AND DILUTED 10,081,147 10,081,147 10,081,147 10,081,147
=========== =========== =========== ===========
See accompanying notes to consolidated financial statements.
2
HAMILTON BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
(In thousands) (Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
------- -------- -------- -------
NET LOSS $(6,168) (17,874) $(28,344) $(5,337)
OTHER COMPREHENSIVE INCOME (LOSS), Net of tax:
Net change in unrealized loss on securities available for sale during period 486 (1,566) 756 91
Less: Reclassification adjustment on realized gain on sale of assets (2,245) (85) (3,439)
Less: Reclassification adjustment for write off a foreign bank stock 1,236 1,508
------- -------- -------- -------
Total 486 (2,575) 671 (1,840)
------- -------- -------- -------
COMPREHENSIVE LOSS $(5,682) $(20,449) $(27,673) $(7,177)
======= ======== ======== =======
See accompanying notes to consolidated financial statements
3
HAMILTON BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Dollars in thousands, except share data) (Unaudited)
Accumulated
Common Stock Other Total
---------------------- Capital Retained Comprehensive Stockholders'
Shares Amount Surplus Earnings Income (Loss) Equity
---------- ------ ------- -------- -------------- -------------
Balance, December 31, 2000 10,081,147 $101 $60,702 $42,151 $(459) $ 102,495
Net change in unrealized loss on
securities available for sale, net of taxes 671 671
Net loss for the nine months ended
September 30, 2001 (28,344) (28,344)
---------- ---- ------- ------- ----- --------
Balance as of September 30, 2001 10,081,147 $101 $60,702 $13,807 $ 212 $ 74,822
========== ==== ======= ======= ===== ========
See accompanying notes to consolidated financial statements.
4
HAMILTON BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands) (Unaudited)
For Nine Months Ended
-----------------------------
September 30
2001 2000
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (28,344) $ (5,337)
Adjustments to reconcile net loss to net cash provided by operating activities
Depreciation and amortization 983 1,110
Provision for credit losses 48,600 33,250
Provision for (recovery of) transfer risk (11,108) 8,379
Deferred tax benefit (9,158) (5,966)
Net gain on sale of other real estate owned (6) (13)
Net gain (loss) on sale of investments 778 (3,794)
Decrease (increase) in accrued interest receivable and other assets 13,684 (560)
(Decrease) increase in other liabilities (3,295) 5,431
----------- ---------
Net cash provided by operating activities 12,134 32,500
----------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Decrease in interest-earning deposits with other banks 83,615 68,213
Purchase of securities available for sale (1,416,112) (800,021)
Proceeds from sales and maturities of securities available for sale 1,321,140 761,647
Proceeds from sale of other real estate owned 33 0
Decrease (increase) in loans-net 208,063 (74,899)
Purchases of property and equipment-net (314) (454)
----------- ---------
Net cash provided by (used in)investing activities 196,425 (45,514)
----------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in deposits (269,844) (6,765)
Payment of other borrowing (14,300) 0
----------- ---------
Net cash used in financing activities (284,144) (6,765)
----------- ---------
NET DECREASE IN CASH AND CASH EQUIVALENTS (75,585) (19,779)
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE PERIOD 129,596 85,110
----------- ---------
CASH AND CASH EQUIVALENTS AT END OF THE PERIOD $ 54,011 $ 65,331
=========== =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid during the period $ 68,657 $ 65,124
=========== =========
Income taxes (refunded) paid during the period, net $ (11,422) $ 7,548
=========== =========
See accompanying notes to consolidated financial statements.
5
HAMILTON BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2001
NOTE 1: BASIS OF PRESENTATION
The consolidated statements of condition for Hamilton Bancorp Inc. and
Subsidiaries (the "Company") as of September 30, 2001 and December 31, 2000, the
related consolidated statements of operations for the three and nine months
ended September 30, 2001, and the related consolidated statements of
comprehensive operations, stockholders' equity and cash flows for the nine
months ended September 30, 2001 and 2000 included in the Form 10-Q have been
prepared by the Company in conformity with the instructions to Form 10-Q and
Article 10 of Regulation S-X and, therefore, do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. The statements are unaudited except for the
consolidated statement of condition as of December 31, 2000.
The accounting policies followed for interim financial reporting are consistent
with the accounting policies set forth in Note 1 to the consolidated financial
statements appearing in the Company's Annual Report on Form 10-K for the year
ended December 31, 2000 as filed with the Securities and Exchange Commission.
NOTE 2: REGULATORY MATTERS, GOING CONCERN AND DIVIDEND RESTRICTIONS
REGULATORY MATTERS - The Office of the Comptroller of the Currency ("OCC") is
currently in the final stages of conducting a safety and soundness examination
of the Bank. The Bank believes the examination will be complete in the fourth
quarter of 2001 and an examination report delivered to the Bank. In connection
with this examination, in September 2001 the OCC advised the Bank of preliminary
findings that the Bank may need to increase its allowance for loan losses
reported in the Bank's Call Report as of June 30, 2001 by up to $12.0 million.
Recently this amount was changed to $11 million. The potential increase in the
allowance resulting from the OCC's preliminary findings include approximately
$7.0 million attributable to differences in loan grades assigned by the OCC and
the Bank, and approximately $4.0 million attributable to changes in the
methodology employed to estimate the allowance for non-graded loans. Although
the OCC has not issued its written report containing the final proposed
adjustments, the Bank has communicated to the OCC its intent to appeal these
findings as to the amount of any additional allowance and the period in which
any additional allowance should be recorded. Pending the conclusion of the
examination and associated appeal process, the Bank has included approximately
$4.2 million in the provision for loan losses for the three months ended
September 30, 2001 as a result of loan classifications assigned by the OCC. In
addition, as of September 30, 2001, the Bank revised certain processes used in
estimating the allowance for loan losses to reflect findings communicated by the
OCC. Management believes these actions taken in the third quarter incorporate
the preliminary findings of the OCC in the determination of the allowance for
loan losses as of September 30, 2001, in all material respects.
Should the Bank be required to amend its June 30, 2001 Call Report as a result
of the matter discussed above, the Company will also amend its consolidated
financial statements included in Form 10-Q for the quarter ended June 30, 2001.
Furthermore, the consolidated financial statements included in this Form 10-Q
for the quarter ended September 30, 2001 would be amended to reduce the
provision for loan losses recorded in the third quarter of 2001 due to the
increased provision recorded in the second quarter of 2001. The estimated effect
of any such amendment would be to increase the consolidated net loss reported
for the quarter ended June 30, 2001 by up to $11.0 million, from $24.7 million
($2.45 per share) to $35.7 million ($3.54 per share). The net loss for the
quarter ended September 30, 2001 of $6.2 million ($.61 per share) would change
to estimated net income of $5.0 million ($.50 per share).
In April 2001, the Compensation Committee of the Board of Directors of the
Company, after consultation with legal counsel, resolved to terminate the
position of several senior officers under and in accordance with their
employment agreements with the Company. The Compensation Committee decided that
the first such senior officer to be terminated would be a former executive
officer who is also the spouse of the chief executive officer of the Company and
the Bank. In connection with the termination, the Bank paid approximately
$592,000 to the executive pursuant to the terms of the contract regarding
termination without cause. The chief executive officer is not a member of the
Compensation Committee and therefore he did not vote on this matter. Subsequent
to the payment, the OCC advised the Bank that a prior application to the OCC and
the Federal Deposit Insurance Corporation ("FDIC") was required due to the
Bank's troubled condition. Because no such prior application was made to and
approved by the OCC and the FDIC, the OCC and the FDIC further advised the Bank
that the severance payment was prohibited under Federal banking regulations. The
Bank subsequently made such an application for the above mentioned officers,
which was denied by the OCC and the FDIC in September 2001. The OCC and the FDIC
have directed the Board of Directors of the Bank to cause restitution to be made
to the Bank. The Board is negotiating with the former executive officer to cause
restitution to be made to the Bank, but there is no assurance that such
negotiations will be successful. If unsuccessful, the OCC has advised the Board
that it expects the Board to take appropriate actions to cause restitution to be
made. At this time, management is unable to predict the ultimate resolution of
this matter or the impact this matter will have on the Company or the Bank.
Insured depository institutions and their holding companies must meet applicable
capital guidelines or be subject to a variety of enforcement remedies, including
dividend restrictions, the issuance of capital directives, the issuance of cease
and desist orders, the imposition of civil money penalties, the termination of
deposit insurance by the FDIC or the appointment of a conservator or receiver.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Company's 99.8% owned subsidiary, Hamilton Bank, N.A.
(the "Bank"), must meet specific capital guidelines that involve quantitative
measures of the Bank's assets, liabilities, and certain off-balance sheet items
as calculated under regulatory accounting practices. The Bank's capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
The Company is subject to risk-based capital and leverage guidelines issued by
the Board of Governors of the Federal Reserve System and the Bank is subject to
similar guidelines issued by the OCC. These guidelines are used to evaluate
capital adequacy and include required minimums.
To be "adequately capitalized" under federal bank regulatory agency definitions,
a depository institution must have a Tier 1 ratio of at least 4%, a total ratio
of at least 8% and a leverage ratio of at least 4%. As of September 30, 2001,
the Bank did not meet all of these minimum percentages. Furthermore, as
discussed below, the Bank is subject to a written agreement to maintain specific
capital levels in excess of minimum requirements. As of December 31, 2000 and
September 30, 2001 the Bank was not in compliance with this agreement.
Furthermore, as discussed below, in June 2001, the OCC reclassified the Bank's
capital category for certain regulatory purposes to "undercapitalized." The
regulatory agencies are required by law to take specific prompt actions with
respect to institutions that do not meet minimum capital standards.
6
In February 2000, the OCC initiated a formal administrative action against the
Bank alleging various unsafe and unsound practices discovered through an
examination of the Bank as of August 23, 1999. On September 8, 2000, the OCC and
the Bank settled the administrative action by entering into a cease and desist
order by consent (the "September 8 Order"). The September 8 Order required the
Bank to comply with, among other things, certain accounting and capital
requirements and to make specified reports and filings. Further, pursuant to the
September 8 Order, the Bank may declare a dividend only if it is in compliance
with the capital levels required by the order and has obtained the prior written
approval of the OCC. The September 8 Order also required the Bank to maintain by
September 30, 2000 Tier 1, Total and leverage capital ratios of 10%, 12% and 7%,
respectively. As of December 31, 2000 and September 30, 2001, the Bank had Tier
1, Total and leverage capital ratios of 9.4%, 10.7% and 6.5%, respectively, and
6.3%, 7.6% and 4.5%, respectively. As a result, the Bank was not in compliance
with the capital requirements of the September 8 Order. Failure of the Bank to
comply with the terms of the September 8 Order could result in the assessment of
civil money penalties, the issuance of an order by a District Court requiring
compliance with the September 8 Order, the placing of restrictions on the source
of deposits or, in certain circumstances, the appointment of a conservator or
receiver. In addition, the FDIC may initiate a termination of insurance
proceeding where there has been a violation of an order.
On March 28, 2001, the OCC issued a Notice of Charges for Issuance of an Amended
Order to Cease and Desist (the "Notice of Charges") against the Bank. The Notice
of Charges alleged that the Bank has violated certain federal banking laws and
regulations by, among other things, (i) making loans in violation of applicable
lending limits; (ii) failing to file accurate Call Reports; (iii) failing to
file Suspicious Activity Reports ("SARs") with respect to certain transactions;
(iv) failing to provide a system of internal controls to ensure ongoing
compliance with the Bank Secrecy Act (the "BSA") and (v) engaging in unsafe and
unsound practices. The Notice of Charges also alleged that the Bank has violated
the September 8 Order by approving certain overdrafts and making certain loans
and has not complied with certain other provisions of the September 8 Order.
Under the Notice of Charges, the OCC seeks the issuance of an Amended Order to
Cease and Desist (the "Proposed Amended Order").
In connection with the issuance of the Notice of Charges, the OCC issued a
Temporary Order to Cease and Desist (the "Temporary Order") also on March 28,
2001. The Temporary Order requires the Bank to, among other things, (i) comply
with specified internal procedures in connection with the making of loans and
overdrafts and the placement of funds; (ii) develop, implement and adhere to a
written program acceptable to the OCC to ensure compliance with the BSA; (iii)
comply with specified procedures with respect to pouches received by the Bank
and existing foreign correspondent accounts; and (iv) develop, implement and
adhere to a written program acceptable to the OCC to ensure compliance with the
requirements to file SARs. In addition, the Temporary Order prohibits the Bank
from engaging in transactions with certain named persons and entities, or with
any parties who provide funding to such persons and entities.
The Proposed Amended Order contains provisions that are substantially the same
as those contained in the Temporary Order, as well as additional requirements.
The additional provisions contained in the Proposed Amended Order would also
require the Bank to, among other things, (i) achieve and maintain Tier 1, Total
and leverage capital ratios of 12%, 14% and 9%, respectively; (ii) develop,
implement and adhere to a three year capital plan acceptable to the OCC; and
(iii) obtain the approval of the OCC with respect to the appointment of new
directors and senior officers.
By letter dated March 28, 2001 (the "PCA Notice"), the OCC notified the
Company of its intent to "reclassify" the capital category of the Bank to
"undercapitalized" for purposes of Prompt Corrective Action ("PCA") based on the
OCC's determination that the Bank is engaging in unsafe and unsound banking
practices. On June 13, 2001, following an informal hearing on the OCC's intent
to reclassify, the Bank was notified that the OCC rendered a decision and
reclassified the Bank's capital category to "undercapitalized" for purposes of
PCA. Prior to this reclassification the Bank's capital category for PCA was
"adequately capitalized." As a result of the reclassification, the Bank is
subject to restrictions on its ability to pay dividends and management fees, and
restrictions on asset growth and expansion. Under the September 8 Order, the
Bank was previously required to obtain prior approval from the OCC for the
payment of any dividends. Additionally, the Bank's waiver from the FDIC
authorizing it to accept brokered deposits is no longer applicable, and a new
waiver must be obtained from the FDIC prior to the acceptance or renewal of any
brokered deposits subsequent to the date of the reclassification. As of
September 30, 2001, the Bank held $10 million of brokered deposits, the
acquisition of which was initiated in the normal course of business on June 6,
2001, prior to receipt of the notification from the OCC, but which were accepted
by the Bank after the notification was received from the OCC. By letter dated
June 28, 2001, the FDIC informed the Bank that receipt of these deposits were an
apparent violation of regulations regarding brokered deposits. As of November
13, 2001, the Bank has received no further communication from the FDIC on this
matter. These deposits will mature on December 17, 2001, at which time the Bank
expects to repay them in the normal course of business.
7
Under PCA, the OCC may impose additional discretionary restrictions by the
issuance of a PCA directive, and after the opportunity for a hearing, if the OCC
determines that such actions are necessary to help resolve the problems of the
Bank at the least possible long term cost to the FDIC. Such additional
discretionary restrictions include requiring recapitalization, restricting
transactions with affiliates, restricting interest rates paid, further
restricting asset growth, restricting activities, improving management and the
board by requiring new members or dismissal of existing members, prohibiting
deposits from correspondent banks, requiring divestiture of subsidiaries of the
Bank (currently the Bank has no subsidiaries) and any other actions the OCC
determines will better resolve the problems of the Bank at the least possible
long term cost to the deposit insurance fund. Additionally, the Federal Reserve
Board (the "FRB") may impose restrictions including requiring prior approval of
the FRB for any capital distributions by the Company (the FRB has notified the
Company that prior approval is required for any such distributions), requiring
divestiture of any affiliate other than an insured depository institution and
requiring divestiture of the Bank if the FRB determines that divestiture would
improve the Bank's financial condition and future prospects.
GOING CONCERN -- The accompanying consolidated financial statements have been
prepared on a going concern basis, which contemplates the realization of assets
and the satisfaction of liabilities in the normal course of business. The
matters discussed above and the uncertainty of what actions the regulators might
take related to them raise substantial doubt about the Company's ability to
continue as a going concern. The consolidated financial statements do not
include the adjustments, if any, that might have been required had the outcome
of the above mentioned uncertainties been known, or any adjustments relating to
the recoverability of recorded asset amounts or the amounts of liabilities that
may be necessary should the Company be unable to continue as a going concern.
Management of the Company believes the Company has several means by which to
achieve compliance with the prescribed capital requirements of the September 8
Order. Such plans initially provide for reducing the Bank's size through
selected asset run-off; the sale of credit risk which effectively decreases the
Bank's regulatory capital requirements; targeted loan sales, including the sale
of the Ecuador portfolio subject to ATRR, and loan participations to other
banks; and shifting assets to liquid investments which decreases regulatory
capital requirements. In addition to the ongoing efforts to bring the Bank into
compliance with the capital requirements of the September 8 Order, the Bank has
taken comprehensive actions to address the matters that have been identified by
the OCC and are subject of the various administrative enforcement proceedings
described herein. Among other things, the Bank has hired a chief financial
officer, enhanced its policies and procedures, conducted extensive Bank Secrecy
Act training, revised its capital plan to include recommendations contained in
the report of examination received in February 2001, enhanced its credit
analysis function and reduced exposure in emerging markets. Management has
submitted a revised business and capital plan to the OCC to take into
consideration the operating results for the period ended September 30, 2001. The
company also appointed a chief operating officer, who subsequently resigned,
effective September 30, 2001.
In addition, in June 2001, the Company engaged CIBC World Markets, an investment
bank, to advise the Company in exploring and evaluating strategic alternatives
to enhance shareholder value. Such alternatives could include but are not
limited to a possible sale or other transfer of all or a significant portion of
the assets or securities of the Company or some other corporate transaction
involving a change in control of the Company. There is no assurance that any of
the foregoing transactions will be consummated.
Further, management of the Company does not believe that the ratios in the
Proposed Amended Order are appropriate or warranted and Management does not
intend to agree to such ratios voluntarily. In addition, Management believes the
timeframes for achieving such ratios set forth in the Proposed Amended Order are
commercially unreasonable.
However, assuming that the ratios were in fact lawfully imposed and that the
Bank was given a reasonable time to achieve such ratios, management believes and
anticipates that the Bank would continue to take the actions outlined above in
an orderly manner to meet required ratios.
The Company's continuation as a going concern is dependent on (i) the Bank's
ability to comply with the terms of regulatory orders and its prescribed capital
requirements and (ii) the severity of the actions that might be taken by
regulators as a result of non-compliance. However, there can be no assurance
that the Bank will be able to comply with such terms and achieve these
objectives.
DIVIDEND RESTRICTIONS -- On March 30, 2001, the Company was advised by the
Federal Reserve Bank of Atlanta (the "FRB"), its primary regulator, that the
Company and Hamilton Capital Trust I should not pay any dividends, distributions
or debt payments without the prior approval of the FRB. The Company obtained
approval from the FRB to pay the dividend payable on April 2, 2001, amounting to
approximately $309,000, on the Series A Beneficial Unsecured Securities (the
"Trust Preferred
8
Securities") issued by Hamilton Capital Trust I (the "Trust"). There can be no
assurance that the FRB will approve any future payments. The Company will not
seek such approval and will not pay dividends on the Trust Preferred until the
Company's financial condition improves. Pursuant to the documents governing the
Trust Preferred Securities, the Company and the Trust have the right, under
certain conditions, to defer dividend payments for up to 20 consecutive
quarters. Any payments deferred in this manner will continue to accumulate.
Pursuant to this right, the Company and the Trust have deferred payment of the
dividend otherwise payable on July 2, 2001 and each quarterly period thereafter,
and, until further notice, expect to defer future payments. As of September 30,
2001, accumulated deferred dividends amounted to approximately $618,000.
NOTE 3: LITIGATION AND CONTINGENCIES
Six class action lawsuits were filed against the Company and certain officers in
the Federal District Court for the Southern District of Florida between January
12 and March 9, 2001. The class actions have been brought purportedly on behalf
of (i) all purchasers of common stock of the Company between April 21, 1998 and
June 8, 2001, and (ii) all purchasers of Hamilton Capital Trust I, series A
shares on or traceable to the December 28, 1998 public offering of those shares.
These cases seek to pursue remedies under the Securities Exchange Act of 1934 or
the Securities Act of 1933. The cases have been consolidated as in Re Hamilton
Bancorp, Inc. Securities Litigation, Case No. 01-156 in the United States
District Court for the Southern District of Florida, and the lead plaintiffs
appointed by the Court have served a consolidated amended complaint which, inter
alia, added a series of additional defendants. All defendants have moved to
dismiss the consolidated complaint, and the discovery process has not yet begun.
Generally, the consolidated complaint alleges that the defendants made false and
misleading statements and omissions between April 21, 1998 and June 8, 2001 with
respect to the Company's financial condition, net income, earnings per share,
internal controls, underwriting of loan transactions, accounting for certain
financial transactions as independent transactions, the credit quality of the
Company's loan portfolio, credit loss reserves, investigation and orders by the
OCC and reporting in accordance with GAAP and related standards, in press
releases, Forms 10-Q filed on May 14, 1998, August 14, 1998, November 16, 1998,
May 17, 1999, August 16, 1999, November 10, 1999, May 16, 2000, August 14, 2000,
and November 28, 2000, Forms 10-Q/A, 10-K/A and 10-K/A-2 filed on December 26,
2000, a Form 12B-25 filed on November 14, 2000, and Forms 10-K filed on March
31, 1999 and April 14, 2000; and a December 1998 Registration Statement and
Prospectus for series A shares of Hamilton Capital Trust I.
Edie Rolando Pinto Lemus V. Hamilton Bank, N.A., was filed in the Federal
District Court for the Southern District of Florida on September 12, 2000. The
complaint alleges counts for civil conspiracy, conversion, unjust enrichment,
money had and received, breach of fiduciary duty, constructive trust, breach of
contract and civil theft. Plaintiff alleges that he is a resident of Guatemala
and that he was a customer of the Bank through two other individuals, who he
also alleges were directors of the Bank. The plaintiff alleges that $9,970,000
was stolen from him and deposited into "his" account at the Bank, which money
was "not returned to him" and thereby converted by the Bank. Plaintiff claims
that this action also constitutes civil theft under Florida statutes and that,
therefore, he is entitled to treble damages. The plaintiff was a customer of the
Bank for a short period of time (less than three months) in 1995. The
allegations in the complaint, however, do not appear to bear any relation to
that account. The plaintiff had previously sued the other two persons in
Guatemala making virtually identical claims. The plaintiff lost that action. The
Company is seeking to have the case dismissed based upon forum non conveniens.
On May 2, 2001, the motion was denied. Exceptions will be filed with the
District Court with a petition for certification for an appeal to the Eleventh
Circuit Court of Appeals in the alternative.
From time to time the Bank is engaged in additional litigation incidental to its
operations.
While any litigation contains an element of uncertainty, the Bank, after
considering the advice of legal counsel, believes the outcome of all
aforementioned litigation will not have a material adverse effect on the Bank's
financial position, results of operations or liquidity.
Hamilton Bank has been advised that an investigation was commenced by Peruvian
authorities of the assignment of certain receivables to Hamilton Bank
in connection with a lending arrangement involving a foreign bank. The foreign
bank had outstanding obligations to Hamilton Bank of approximately $7 million,
and a borrower related to the foreign bank had outstanding obligations of
approximately $11 million. The foreign bank assigned receivables having a face
value of approximately $22 million to Hamilton Bank in connection with the $7
million loan. An amendment to the credit agreement between Hamilton Bank and
the foreign bank extended Hamilton Bank's lien on the receivables to obligations
of parties related to the foreign bank. The nature of the investigation, as
Hamilton Bank understands it, is to ascertain whether any criminal acts were
committed in connection with the assignment to Hamilton Bank. In October 2001,
Hamilton Bank was advised that the preliminary investigation has been completed
and a report issued that clears Hamilton Bank of any criminal actions in
connection with the assignment.
Subsequent to the assignment of the receivables, the foreign bank was intervened
by Peruvian banking authorities. Hamilton Bank has been informally advised that
the Intervenor has instituted civil proceedings in Peru against Hamilton Bank to
nullify the amendment to the credit agreement which resulted in the assignment
of the receivables. Hamilton Bank has not been officially notified of this
lawsuit in accordance with Peruvian law. The Intervenor claims the provisions of
the amendment, which is governed by Florida law, providing for automatic default
upon insolvency violated the public policy of Peru and also alleges that the
collateral exceeded the obligations owed to Hamilton Bank. Hamilton Bank denies
the accusations, and local Peruvian counsel is of the opinion that the
provisions of the amendment are permissible under local laws and do not violate
the public policy of Peru. Hamilton Bank has not been served any formal notice
of the investigation, and is unable to predict any outcome.
9
NOTE 4: NET LOSS PER COMMON SHARE
Basic loss per share is computed by dividing the Company's net loss by the
weighted average number of shares outstanding during the period. Diluted loss
per share is computed by dividing the Company's net loss by the weighted average
number of shares outstanding and the dilutive impact of potential common stock,
primarily stock options. The dilutive impact of common stock is determined by
applying the treasury stock method.
10
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
Hamilton Bancorp Inc. ("Bancorp") is a bank holding company that conducts
operations principally through its 99.8 percent subsidiary, Hamilton Bank, N.A.
(the "Bank" and, collectively with Bancorp, the "Company"). The Bank is a
national bank which specializes in financing trade flows between domestic and
international companies on a global basis, with particular emphasis on trade
with and between South America, Central America, the Caribbean (collectively,
the "Region") and the United States. The Bank has a network of nine FDIC-insured
branches with eight Florida locations in Miami, Sarasota, Tampa, West Palm
Beach, Winter Haven and Weston, and a branch in San Juan, Puerto Rico.
The economies of various countries in the Region have been characterized by
frequent and occasionally drastic intervention by the governments and volatile
economic cycles. Governments have often changed monetary, credit, tariff and
other policies to influence the course of their respective economies. The
actions of the governments to control inflation and effect other policies have
often involved wage and price controls as well as other interventionist
measures, such as Ecuador's freezing of bank accounts early in 1999. Changes in
policies of countries in the Region involving tariffs, exchange controls,
regulations and taxation could significantly increase the likelihood of causing
restrictions on transfers of Dollars out of such countries, as could inflation,
devaluation, social instability and other political, economic or diplomatic
developments.
Financial and securities markets of countries in the Region, are, to varying
degrees, influenced by economic and market conditions in other emerging market
countries and other countries in the Region. Although economic conditions are
different in each country, investor reaction to developments in one country can
have significant effects on the financial markets and securities of issuers in
other countries. Over the years, developments in other countries or regions of
the world have adversely affected the securities and other financial markets in
many emerging markets, including countries where the Company may conduct
business currently or in the future. A result of these difficulties has been the
closing, intervention or forced consolidation of numerous banks in some
countries in the Region. These systemic collapses have a significant adverse
economic effect on the economies of the countries involved. There can be no
assurance that the various financial and securities markets in the Region will
not continue to be adversely affected by events elsewhere, especially in other
emerging markets and in other countries in the Region.
At September 30, 2001, approximately 44% of the Company loans were extended to
borrowers located outside of the U.S., primarily in countries within the Region.
As a result, the economic conditions in countries within the Region could have a
significant impact on the Company's financial condition and results of
operations.
FINANCIAL CONDITION - SEPTEMBER 30, 2001 VS. DECEMBER 31, 2000.
Total consolidated assets decreased $331 million to $1.41 billion at September
30, 2001 from $1.74 at December 31, 2000. The decrease included a decline of
$228 million in interest-earning assets $131 million in non-interest earning
assets (primarily cash which was redeployed) and a reduction of $37 million in
allocated transfer risk reserves . The decrease in total assets is attributable
primarily to activities undertaken to achieve compliance with capital ratio
requirements imposed on the Bank, as more fully discussed under " CAPITAL
RESOURCES, REGULATORY MATTERS, GOING CONCERN AND DIVIDEND RESTRICTIONS" below.
CASH, DEMAND DEPOSITS WITH OTHER BANKS AND FEDERAL FUNDS SOLD
Cash, demand deposits with other banks and federal funds sold are considered
cash and cash equivalents. Balances of these items fluctuate daily depending on
many factors that include or relate to the particular banks that are clearing
funds, loan payoffs, deposit gathering and reserve requirements. Cash and demand
deposits with other banks were $15.2 million at September 30, 2001 compared to
$125.3 million at December 31, 2000. The amount of cash held at December 31,
2000 was temporarily higher than normal and the balance held at September 30,
2001 is within a normalized range.
11
INTEREST-EARNING DEPOSITS WITH OTHER BANKS AND INVESTMENT SECURITIES
Interest-earning deposits with other banks decreased to $26.4 million at
September 30, 2001 from $110.0 million at December 31, 2000. These deposits are
placed with correspondent banks in the Region, generally on a short-term basis
(less than 365 days), to increase yields and enhance relationships with the
correspondent banks. The level of such deposits has diminished concurrent with
management's strategy to reduce its exposure in the Region during the nine
months ended September 30, 2001. In addition, approximately $5.5 million of the
decrease represents a time deposit that was transferred to loans and charged
off. This deposit was related to a foreign bank, which failed to repay the
deposit at maturity. Also, in connection with the sale of certain Ecuadorian
exposure during the third quarter, a deposit with a face amount of $6 million
was sold for proceeds of $3.6 million.
Investment securities increased to $347.4 million at September 30, 2001 from
$255.3 million at December 31, 2000. The increase reflects $133.7 million in
U.S. Government and Agency securities, which rose from $168.6 million at
December 31, 2000 to $302.3 million at September 30, 2001. This increase was
partly offset by a decrease of $31.8 million in foreign debt securities, which
were sold during the period to reduce capital requirements and improve
liquidity. Proceeds from reductions in loans, in excess of the amounts used to
fund deposit maturities, were invested in securities.
LOANS
The Company's gross loan portfolio decreased by $272 million or 22 percent,
during the first nine months of 2001 in relation to the balance at December 31,
2000. Domestic commercial real estate loans increased by $48.9 million or 59
percent. This increase was offset by decreases in all other loan categories,
primarily in foreign loans of $266.2 million or 38 percent. Approximately $41.8
million of the decrease in loans represents amounts charged off during the first
nine months of 2001. See "Credit Loss and Transfer Risk Experience" below. In
connection with Management's plans to achieve compliance with required capital
ratios (see "CAPITAL RESOURCES, REGULATORY MATTERS, GOING CONCERN AND DIVIDEND
RESTRICTIONS" below), total loans are expected to continue to decrease for the
remainder of 2001.
Details on the loans by type are shown in the table below. At September 30,
2001, approximately 55.7 percent of the Company's portfolio consisted of loans
to domestic borrowers compared to 43.9 percent at December 31, 2000 and 40.1
percent at December 31, 1999, reflecting the increasing emphasis on domestic
activities in connection with management's strategy to diversity the Bank's risk
profile and, more recently, reductions in total loans outstanding as part of
management's capital management strategy.
The following table sets forth the loans by type in the Company's loan portfolio
at the dates indicated.
12
LOANS BY TYPE
(in thousands)
September 30, 2001 December 31, 2000
------------------ -----------------
Domestic:
Commercial and industrial (1) $ 342,089 $ 380,926
Commercial real estate 131,942 83,082
Acceptances discounted 60,340 76,148
Residential mortgages 1,411 1,812
--------- -----------
Subtotal Domestic 535,782 541,968
--------- -----------
Foreign:
Banks and other financial institutions 58,758 153,119
Commercial and industrial (1) 321,719 405,152
Acceptances discounted 36,681 64,100
Government and official institutions 8,893 69,841
--------- -----------
Subtotal Foreign 426,051 692,212
--------- -----------
Total Loans $ 961,833 $ 1,234,180
========= ===========
(1) Includes pre-export financing, warehouse receipts and refinancing of letter
of credits.
The following tables present the Company's loans by country and cross-border
outstandings by country. The aggregate amount of the Company's cross-border
outstandings by primary credit risk include cash and demand deposits with other
banks, interest earning deposits with other banks, investment securities, due
from customers on bankers acceptances, due from customers on deferred payment
letters of credit and loans, net of related deposits. Exposure levels in any
given country at the end of each period may be impacted by the flow of trade
between the United States (and to a large extent Florida) and the given
countries, as well as the price of the underlying goods or commodities being
financed.
At September 30, 2001 approximately 26.2 percent in principal amount of the
Company's loans were outstanding to borrowers in four countries other than the
United States: Panama (11.8 percent), Guatemala (6.2 percent), El Salvador (5.5
percent) and Nicaragua (2.7%).
Panama loan exposure continues to be over 10 percent of loans at September 30,
2001. The bulk of the credit relationships in Panama are related to financing
short-term trade transactions with companies operating out of the Colon Free
Zone. The latter represents the second largest free trading zone in the world
after Hong Kong. The companies operate largely as importers and exporters of
consumer goods such as electronic goods and clothing.
13
LOANS BY COUNTRY
(Dollars in thousands)
September 30, 2001 December 31, 2000
-------------------------------- ---------------------------------
Percent of Percent of
Country Amount Total Loans Amount Total Loans
--------- ----------- ----------- -----------
United States $ 535,782 55.7% $ 541,968 43.9%
Argentina 5,757 0.6% 13,943 1.1%
British West Indies 19,151 2.0% 24,115 2.0%
Colombia 16,305 1.7% 21,176 1.7%
Dominican Republic 16,895 1.8% 36,374 3.0%
Ecuador 8,672 0.9% 53,688 4.4%
El Salvador 52,790 5.5% 55,871 4.5%
Guatemala 59,760 6.2% 105,945 8.6%
Honduras 21,414 2.2% 38,232 3.1%
Jamaica 5,620 0.6% 49,346 4.0%
Mexico 15,449 1.6% 7,821 0.6%
Nicaragua 25,603 2.7% 22,527 1.8%
Panama 113,128 11.8% 138,425 11.2%
Peru 15,173 1.6% 37,494 3.0%
Venezuela 11,344 1.2% 16,632 1.3%
Other (1) 38,990 3.9% 70,623 5.8%
--------- ----- ----------- -----
Total $ 961,833 100.0% $ 1,234,180 100.0%
========= ===== =========== =====
(1) Other consists of loans to borrowers in countries in which loans did not
exceed 1 percent of total loans.
14
At September 30, 2001 approximately 19.55 percent of total assets were
cross-border outstandings to borrowers in five countries other than the United
States: Panama ( 7.08 percent), El Salvador ( 4.96 percent), Guatemala (4.25
percent), Nicaragua ( 1.84 percent) and the Dominican Republic ( 1.42 percent).
The Company's cross-border outstandings in Argentina decreased from $55 million
at December 31, 2000 to $3 million at September 30, 2001. As a result of the
economic uncertainties in Argentina, the Company reduced its exposure.
TOTAL CROSS-BORDER OUTSTANDING BY COUNTRY (2)
(Dollars in millions)
September 30, 2001 December 31, 2000
--------------------- -----------------------
% of Total % of Total
Amount Assets Amount Assets
------ ---------- ------- ----------
Argentina $ 3 0.2% $ 55 3.1%
Bolivia 5 0.4% 12 0.7%
Brazil 8 0.6% 20 1.1%
British Virgin Island 2 0.1% 18 1.0%
Colombia 17 1.2% 22 1.3%
Dominican Republic 20 1.4% 41 2.3%
Ecuador 10 0.7% 63 3.6%
El Salvador 70 5.0% 60 3.4%
Guatemala 60 4.3% 105 6.0%
Honduras 17 1.2% 29 1.7%
Jamaica 5 0.4% 50 2.9%
Mexico 16 1.1% 8 0.5%
Nicaragua 26 1.8% 20 1.1%
Panama 100 7.1% 139 7.9%
Peru 23 1.6% 38 2.2%
Suriname 5 0.4% 31 1.8%
Venezuela 13 0.9% 17 1.0%
Other (1) 34 2.4% 60 3.4%
----- ---- ----- ----
Total $ 434 30.8% $ 788 45.0%
===== ==== ===== ====
(1) Other consists of cross-border outstanding to countries in which such
cross-border outstanding did not exceed 0.75 percent of the Company's
total assets at any of the dates shown.
(2) Cross-border outstanding could be less than loans by country since
cross-border outstanding may be netted against legally enforceable,
written guarantees of principal or interest by domestic or other
non-local third parties. In addition, balances of any tangible, liquid
collateral may also be netted against cross-border outstanding of a
country if they are held and realizable by the lender outside of the
borrower's country.
15
CONTINGENT LIABILITIES
The following table sets forth the distribution of the Company's contingent
liabilities by country of the applicant and issuing bank for import and export
letters of credit, respectively. As shown by the table, contingent liabilities
decreased by 40 percent from December 31, 2000 to September 30, 2001. In
connection with slowing economic activity in the Region, and the Company's lower
level of lending activity, letter of credit issuance volume has decreased.
CONTINGENT LIABILITIES (1)
(in thousands)
September 30, 2001 December 31, 2000
------------------ -----------------
Dominican Republic $ 12,525 $ 23,880
Ecuador 403 2,305
El Salvador 7,089 1,651
Guatemala 5,705 12,347
Guyana 100 2,107
Haiti 43 1,069
Honduras 1,199 1,957
Jamaica 10,179 10,194
Panama 4,628 7,564
Paraguay 451 2,398
Peru 770 2,337
Suriname 1,127 2,248
United States 49,246 85,617
Other (2) 2,494 4,110
-------- ---------
Total $ 95,959 $ 159,784
======== =========
(1) Includes export and import letters of credit, standby letters of credit
and letters of indemnity.
(2) Other includes those countries in which contingencies represent less
than 1 percent of the Company's total contingencies at each of the
above dates.
CREDIT QUALITY REVIEW
Allowances are established against the loan portfolio to provide for credit
losses and transfer risk. Transfer risk, defined by Federal banking regulators
as allocated transfer risk reserves ("ATRR"), is associated with certain
portions of the Company's foreign exposure. The level of ATRR is determined by
Federal banking regulators and represents a minimum allowance required for the
related exposure. The Company assesses the probable losses associated with that
portion of the loan portfolio that is subject to the ATRR, and if an additional
allowance is needed it is included in the allowance for credit losses.
ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses reflects management's judgment of the level of
allowance adequate to provide for potential losses inherent in the loan
portfolio as of the balance sheet date. The allowance takes into consideration
the following factors: (i) the economic conditions in those countries in the
Region in which the Company conducts lending activities; (ii) the credit
condition of its customers and correspondent banks, as well as the underlying
collateral, if any; (iii) historical experience and (iv) the average maturity of
its loan portfolio and (v) political and economic conditions in certain
countries of the Region.
On a quarterly basis, the Bank assesses the overall adequacy of the allowance
for credit losses, utilizing a disciplined and systematic approach which
includes the application of a specific allowance for identified impaired loans,
an allocated formula allowance for identified graded loans and all other
portfolio segments, and an unallocated allowance.
16
Specific allowances are established for impaired loans in accordance with
Statement of Financial Accounting Standards No. 114, "Accounting by Creditors
for Impairment of a Loan." A loan is considered impaired when, based on current
information and events, it is probable that the Company will be unable to
collect the scheduled payments of principal or interest when due according to
the contractual terms of the loan agreement. Factors considered by management in
determining impairment include payment status, collateral value and the
probability of collecting scheduled principal and interest payments when due.
Loans that experience insignificant payment delays and payment shortfalls
generally are not classified as impaired. Impairment is measured on a loan by
loan basis for non-homogenous loans by either the present value of expected
future cash flows discounted at the loans effective interest rate, the loans
obtainable market price, or the fair value of the collateral if the loan is
collateral dependent.
The allocated formula allowance is calculated by applying loss factors to
outstanding loans based on the internal risk grade of such loans. Changes in
risk grades of both performing and nonperforming loans affect the amount of the
allocated formula allowance. Loss factors are based on our historical loss
experience or on loss percentages used by our regulators for similarly graded
loans and may be adjusted upward for significant factors that, in management's
judgment, affect the collectibility of the portfolio as of the evaluation date.
Loss factors are described as follows:
- - Problem-graded loan loss factors are derived from loss percentages
required by our banking regulators for similarly graded loans. Loss
factors of 2 to 5%, 15% and 50% are applied to the outstanding balance
of loans internally classified as special mention, substandard and
doubtful, respectively.
- - Pass-graded loan loss factors are based on net charge-offs (i.e.,
charge-off less recoveries) to average loans. The Company's current
methodologies incorporate prior year net charge-offs, three year
average net charge-offs and five year average net charge-offs and are
used to compute a range of probable losses.
The unallocated allowance is established based upon management's evaluation of
various conditions, the effects of which are not directly measured in the
determination of the allocated allowances. The evaluation of the inherent loss
with respect to these conditions is subject to a higher degree of uncertainty
because they are not identified with specific problem credits or portfolio
segments. The conditions evaluated in connection with the unallocated allowance
include, but are not limited to, the following factors, which existed at the
balance sheet date:
- - General economic and business conditions affecting the Region;
- - Loan volumes and concentrations;
- - Credit quality trends;
- - Collateral values;
- - Bank regulatory examination results; and
- - Findings of our internal credit examiners
Management reviews these conditions quarterly with our senior credit officers.
To the extent that any of these conditions is evidenced by a specifically
identifiable problem credit as of the evaluation date, management's estimate of
the effect of such condition may be reflected as a specific allowance applicable
to such credit. Where any of these conditions is not evidenced by a specifically
identifiable problem credit or reflected in the formula allowance as of the
evaluation date, management's evaluation of the probable loss related to such
condition is reflected in the unallocated allowance.
The methodologies utilized by the Bank include several features that are
intended to reduce the difference between estimated and actual losses. The loss
factors that are used to establish the allowance for pass-graded loans is
designed to be self-correcting by taking into account changes in loan
classification and permitting adjustments based on management's judgment of
significant qualitative factors as of the evaluation date. Similarly, by basing
the pass-graded loan loss factors on loss experience over the prior year and the
last three or five years, the methodology is designed to take our recent loss
experience into account. The Bank generally operates a commercial banking
business, which does not include significant amounts of pooled loans or loans
that are homogeneous in nature such as residential mortgages or consumer
installment loans (these represent 0.1% of gross loans at both September 30,
2001 and December 31, 2000).
17
ALLOCATED TRANSFER RISK RESERVES
Management determines the level of ATRR utilizing the guidelines of the
Interagency Country Exposure Review Committee ("ICERC"). The ICERC was formed by
the OCC, FDIC and FRB to ensure consistent treatment of the transfer risk
associated with banks' foreign exposures. Transfer risk is defined as the
possibility that an asset cannot be serviced in the currency of payment because
of a lack of, or restraints on the availability of, needed foreign exchange in
the country of the obligor. The ICERC guidelines state that transfer risk is one
facet of the more broadly defined concept of country risk. Country risk, which
has an overarching effect on the realization of an institution's foreign assets,
encompasses all of the uncertainties arising from the economic, social, and
political conditions in a country. The ATRR ratings assigned by ICERC focus
narrowly on the availability of foreign exchange to service a country's foreign
debt, and represent the minimum required reserves for exposures that are subject
to the ATRR provisions. ICERC meets several times a year to assess transfer risk
in various countries, based largely on the level of aggregate exposure held by
U.S. banks. Based on these assessments, ratings are established for individual
countries. In establishing the ratings, ICERC does not consider the credit risk
associated with individual counter parties in a country.
A country may be rated "value impaired" based on ICERC's assessment of transfer
risk. A value impaired country is one which has protracted arrearages in debt
service, as indicated by one or more of the following: i) the country has not
fully paid its interest in nine months, ii) the country has not complied with
International Monetary Fund programs and there is no immediate prospect for
compliance, iii) the country has not met rescheduling terms for more than one
year, iv) the country shows no definite prospects for an orderly restoration of
debt service in the near future. Once a country has been rated value impaired,
the requirements for ATRR are applicable for exposures to borrowers in that
country. Generally, any obligation to a borrower in such a country will be
subject to ATRR if the obligation becomes more than 30 days past due, or if it
is restructured at any time to avoid delinquency. Once the ATRR is applicable,
it can only be eliminated by charge-off of the asset, collection of the asset,
or removal of the ATRR requirement by ICERC. Changes in the level of ATRR
recorded by the Company, including increases resulting from higher requirements
or applicable loans, and decreases resulting from lower requirements or
collections of loans, are charged or credited to current income. Charge-offs of
loans subject to ATRR requirements are charged against the ATRR to the extent of
the ATRR applicable to that loan, and any excess is charged to the general
allowance for credit losses.
Currently, Ecuador is rated value impaired by ICERC, with a 90% ATRR requirement
for applicable exposures. At September 30, 2001 and December 31, 2000, the
Company had aggregate exposure to borrowers located in Ecuador of approximately
$10 million and $63 million, respectively.
The following table sets forth the composition of the allowance for credit
losses and ATRR as of September 30, 2001 and December 31, 2000 (in thousands):
SEPTEMBER 30, 2001 DECEMBER 31, 2000
------------------ -----------------
Allocated:
Specific (Impaired loans) $ 21,054 $ 17,816
Formula 30,019 24,144
Unallocated 789 1,107
-------- ----------
Total allowance for credit losses 51,862 43,067
Allocated transfer risk reserve 130 36,607
-------- ----------
Total allowance and reserves $ 51,992 $ 79,674
======== ==========
The specific allowances increased from $17.8 million at December 31, 2000 to
$21.1 million at September 30, 2001 due to loans charged off during the nine
months ended September 30, 2001, offset by allowances required for new loans
becoming impaired. Impaired loans increased from $54.2 million at December 31,
2000 to $64.9 million at September 30, 2001. At September 30, 2001,
approximately $9.5 million of impaired loans were to U.S. borrowers, and
approximately $55.4 million were to foreign borrowers. The formula-based
allowance increased from $24.1 million at December 31, 2000 to $30.0 at
September 30, 2001 due to a higher level of problem-graded loans subject to
formula-based allowance and an increase in the historic loss factor used to
estimated potential future losses in the non-graded segment of the loan
portfolio.
18
The total allowance for credit losses increased $8.8 million at September 30,
2001, compared to December 31, 2000, based on management's assessment of factors
impacting identified problem graded loans and qualitative factors impacting the
portfolio. The allowance at September 30, 2001 includes the impact of certain
preliminary findings of the OCC in connection with its most recent examination,
which is not yet concluded. Included in impaired loans and the allowance for
credit losses at September 30, 2001 is $5.4 million and $2.7 million,
respectively, associated with a group of loans placed on non-accrual status at
the direction of the OCC. The OCC, in its preliminary findings communicated to
the Bank in September 2001, indicated its belief that these items should have
been included in impaired loans and the allowance for loan losses as of June 30,
2001. Management intends to appeal the OCC's findings that these loans should be
placed on nonaccrual status, and the amount of allowance that should be
allocated to them. Additionally, management revised the process by which it
determines the estimated allowance for the non-graded portion of the portfolio
as of September 30, 2001. See "REGULATORY MATTERS" and "Nonperforming Loans" for
additional discussion.
During the nine months ended September 30, 2001, loan charge-offs totaled $41.8
million, including $33.7 million charged off during the second quarter of 2001
and $4.3 million charged off during the third quarter. Included in the second
quarter charge-offs were $20.4 million of loans, which had previously been on
nonaccrual status, which management, deemed appropriate to charge-off given
their collection prospects. Included in these chargeoffs was $8.8 million
comprised of unsecured trade obligations related to a Panamanian corporate
borrower that was unsuccessful in reorganizing its debt and ceased operations
during the second quarter. Also included was $4.5 million to a domestic borrower
that is operating in bankruptcy. During the second quarter, management obtained
independent information regarding the value of assets and wrote the loan down to
an amount that approximates the estimated value of the assets. Additionally,
chargeoffs during the second quarter included $4.3 million related to a loan
secured by real estate in Venezuela. This loan has been the subject of
protracted litigation wherein the Bank has attempted to gain possession of the
real estate or otherwise collect on the loan. Due to the uncertainties of
achieving success in this effort, and the uncertainty of the timing of
resolution, the loan was charged off. The Bank continues to pursue collection of
this loan.
Also included in second quarter chargeoffs was $13.3 million related to loans
that were not previously on nonaccrual status. One charge off in the amount of
$5.5 million was a time deposit with a foreign bank that was transferred to
loans. The foreign bank was unable to obtain alternative financing at maturity
during the second quarter. Under a temporary cease and desist order (see
"CAPITAL RESOURCES, REGULATORY MATTERS, GOING CONCERN AND DIVIDEND RESTRICTIONS"
below), the Bank is prohibited from renewing this facility and, as a result, it
was charged off. Approximately $3.7 million of the charge-offs not previously on
nonaccrual status were to related borrowers where management uncovered evidence
of possible fraudulent activities involving the borrowers. A scheduled principal
reduction was not made and management determined to charge-off these amounts.
Also, approximately $3.7 million involved two related borrowers, which
experienced rapid financial deterioration in the second quarter and a third
borrower, which conducted substantial business with these borrowers.
During the third quarter of 2001, the Company sold approximately $38.3 million
of its Ecuadorian exposure for $22.3 million in cash. The assets sold included
$32.3 million that was subject to a 90% ATRR, and $6.0 million that was not
subject to ATRR. As a result of these transactions, required ATRR was reduced by
$29 million, including $13.7 million to reflect the charge-off for loans sold
for less than face value, and reversal of $15.4 million recovered as a result of
the sales and included as recovery of ATTR in the consolidated statement of
operations for the period ended September 30, 2001. Additionally, the Company
incurred a loss of $2.4 million in connection with the sale of a bank placement
that was not subject to ATRR and was included in the Ecuadorian assets sold. The
assets sold included $16 million related to one borrower, which were sold to an
affiliate of such borrower. All sales were made without recourse to Hamilton
Bank.
After the sale of the Ecuadorian assets discussed above, the Company held $12.9
of Ecuadorian exposure, which was subject to $11.6 million ATRR. These assets
included $12.7 million related to a bank owned by the Ecuadorian government. The
Company has been in discussions to sell these assets, however, there is
currently no agreement to sell, and prospects are uncertain. During the third
quarter, the Ecuadorian government commenced activities to transfer the assets
of the bank to third parties, which added further uncertainty to the Company's
prospects for sale of the assets related to the bank. Based on the foregoing,
management determined to write down the assets related to the bank to 10% of
their face amount by applying a charge-off against the existing ATRR, and to
place the remaining balance of $1.2 million on non-accrual status.
Determining the appropriate level of the allowance for credit losses requires
management's judgment, including application of the factors described above to
assumptions and estimates made in the context of changing political and economic
conditions in many of the countries of the Region. Accordingly, there can be no
assurance that the Company's current allowance for credit losses will prove to
be adequate in light of future events and developments.
19
The following table provides certain information with respect to the Company's
allowance for credit losses and ATRR activity for the periods shown.
CREDIT LOSS AND TRANSFER RISK EXPERIENCE
(in thousands)
Nine Months Ended Year Ended
September 30, 2001 December 31, 2000
------------------ -----------------
Balance of allowance for credit losses at beginning of period $ 43,067 $ 21,411
Charge-offs:
Domestic:
Commercial (9,169) (16,420)
Acceptances (3,555) (297)
------------ ------------
Total Domestic (12,724) (16,717)
------------ ------------
Foreign:
Banks and other financial institutions (5,616) --
Commercial and industrial (23,007) (7,504)
Acceptances (441) --
------------ ------------
Total Foreign (29,064) (7,504)
------------ ------------
Total charge-offs (41,788) (24,221)
------------ ------------
Recoveries:
Domestic:
Commercial 1,977 10
Installment 3 --
Mortgage 2 --
Foreign:
Commercial -- 48
Banks and other financial institutions 1 70
------------ ------------
Total recoveries 1,983 128
------------ ------------
Net (charge-offs) recoveries (39,805) (24,093)
Provision for credit losses 48,600 45,749
------------ ------------
Balance at end of the period 51,862 43,067
------------ ------------
ATRR at beginning of period 36,607 32,720
Charge-offs to ATRR (25,369) (301)
Provision for (recovery of) ATRR (11,108) 4,188
------------ ------------
ATRR end of period 130 36,607
------------ ------------
Allowance and ATRR at end of period $ 51,992 $ 79,674
============ ============
Average loans $ 1,168,109 $ 1,183,613
Total loans $ 961,833 $ 1,234,180
Net charge-offs to average loans 3.41% 2.04%
Allowance for credit losses to total loans 5.39% 3.49%
Allowance for credit losses and ATRR to total loans 5.41% 6.46%
See "Credit Quality Review" above for a discussion of charge-off activity during
the nine months ended September 30, 2001.
The following tables set forth an analysis of the allocation of the allowance
for credit losses by category of loans and the allowance for credit losses
allocated to foreign loans. The allowance is established to cover potential
losses inherent in the portfolio as a whole or is available to cover potential
losses on any of the Company's loans.
20
ALLOCATION OF ALLOWANCE FOR CREDIT LOSSES AND TRANSFER RISK
(in thousands)
As of As of
September 30, 2001 December 31, 2000
------------------ -----------------
Allocation of the allowance by type of loans:
Domestic:
Commercial $ 17,325 $ 9,412
Commercial real estate 1,139 1,332
Acceptances 437 554
Residential mortgages 4 5
------------ ------------
Total domestic 18,905 11,303
------------ ------------
Foreign non-ATRR
Banks and other financial institutions 1,354 8,063
Commercial and industrial 30,721 23,013
Acceptances discounted 790 390
Government and official institutions 92 298
------------ ------------
Total foreign non-ATRR 32,957 31,764
------------ ------------
Foreign ATRR
Banks and other financial institutions -- 15,282
Commercial and industrial 130 13,473
Government and official institutions -- 7,852
------------ ------------
Total foreign ATRR 130 36,607
------------ ------------
Total Foreign 33,087 68,371
------------ ------------
Total $ 51,992 $ 79,674
============ ============
Percent of loans in each category to total loans:
Domestic:
Commercial 35.5% 30.9%
Commercial real estate 13.7% 6.7%
Acceptances 6.3% 6.2%
Residential 0.2% 0.2%
------------ ------------
Total domestic 55.7% 44.0%
------------ ------------
Foreign Non-ATRR:
Banks and other financial institutions 6.1% 11.0%
Commercial and industrial 33.5% 31.7%
Acceptances discounted 3.8% 5.2%
Government and official institutions 0.9% 4.9%
------------ ------------
Total foreign non-ATRR 44.3% 52.8%
------------ ------------
Foreign ATRR
Banks and other financial institutions 0.0% 1.4%
Commercial and industrial 0.0% 1.1%
Government and official Institutions 0.0% 0.7%
------------ ------------
Total foreign ATRR 0.0% 3.2%
------------ ------------
Total foreign 44.3% 56.0%
------------ ------------
Total 100.0% 100.0%
============ ============
21
ANALYSIS OF ALLOWANCE FOR CREDIT LOSSES ALLOCATED TO FOREIGN LOANS
(in thousands)
September 30, 2001 December 31, 2000
------------------ ------------------
Balance, beginning of year $ 68,371 $ 50,653
Provision for credit losses 30,256 21,217
Provision for (recovery of) ATRR (11,108) 4,188
Net charge-offs (54,432) (7,687)
------------ ------------
Balance, end of period $ 33,087 $ 68,371
============ ============
Composition at end of period
Allowance for credit losses $ 32,957 $ 31,764
Allowance for transfer risk (ATRR) 130 36,607
------------ ------------
Total foreign allowances $ 33,087 $ 68,371
============ ============
The Company does not have a rigid charge-off policy but instead charges off
loans on a case-by-case basis as determined by management and approved by the
Board of Directors. In some instances, loans may remain in the nonaccrual
category for a period of time during which the borrower and the Company
negotiate restructured repayment terms.
The following table sets forth information regarding the Company's nonperforming
loans at the dates indicated.
NONPERFORMING LOANS
(in thousands)
September 30, 2001 December 31, 2000
------------------ -----------------
Domestic:
Non accrual $ 9,490 $ 23,958
Past due over 90 days and accruing 1,121 105
------------ ------------
Total domestic nonperforming loans 10,611 24,063
------------ ------------
Foreign:
Non accrual 55,401 30,250
Past due over 90 days and accruing 9,023 322
------------ ------------
Total foreign nonperforming loans 64,424 30,572
------------ ------------
Total nonperforming loans $ 75,035 $ 54,635
============ ============
Total nonperforming loans to total loans 7.80% 4.43%
Total nonperforming assets to total assets 5.32% 3.14%
Nonaccrual loans were $54.2 million at December 31, 2000 and $64.9 million at
September 30, 2001. The increase during this period results from new loans
placed on nonaccrual status during the third quarter, partly offset by
charge-offs as discussed above under "Credit Quality Review."
Nonaccrual loans at September 30, 2001 included a group of related loans
aggregating approximately $11 million arising from a workout arrangement and
which includes $5.4 million that are on nonaccrual status pursuant to
instructions received from the OCC. In late 2000, the Bank received the
assignment of receivables with an aggregate face value of approximately $22
million in connection with a loan extended to a Peruvian bank in the amount of
$7.2 million. The credit agreement with the Peruvian bank allowed for the lien
on these receivables to be extended to any loan made by the Bank to any related
entity of the Peruvian bank. The $11 million loan referred to above was made to
a related entity of the Peruvian Bank. Following the intervention of the
Peruvian bank by local banking authorities, the Bank commenced negotiations with
the debtors of the assigned receivables to convert the assignments into direct
obligations payable to Hamilton Bank. As of September 30, 2001, the Bank had
received cash payments on the assigned receivables, or executed promissory notes
with the debtors of such receivables to fully offset the original $7.2 million
loan, and $5.4 million of the original $11 million loan. In support of the
remaining $5.6 million of the original $11 million loan, the Bank has assigned
receivables from debtors which management believes are creditworthy, aggregating
$5.4 million. The debtors of these receivables are withholding payment pending
resolution of matters discussed in the following paragraph. Additionally, cash
proceeds of approximately $1.4 million from repayments of the assigned
receivables, which were made to the Peruvian bank under the supervision of the
local banking authorities, are being held in an escrow account in the name of
Hamilton Bank, pending resolution of certain matters as discussed further below.
Also pending such resolution, management placed the $5.6 million on nonaccrual
status as of September 30, 2001.
22
Banking authorities in Peru commenced an investigation of the assignment of
receivables in connection with the $11 million loan discussed above, and have
requested that Hamilton Bank return such receivables. Hamilton Bank has been
advised that a preliminary investigation has been concluded which cleared
Hamilton Bank of any criminal actions in connection with the assignment. The
Intervenor of the Peruvian bank has also commenced a civil action seeking to
nullify the credit agreement which assigned the receivables to Hamilton Bank.
Hamilton Bank has refused to return the receivables based on advice of Peruvian
counsel obtained concurrent with the original assignment, and subsequently
reaffirmed, that such assignment was valid under local law. Based on its
assessment of the foregoing circumstances, in September 2001 the OCC advised the
Bank the entire $11 million loan should be placed on nonaccrual status as of
June 30, 2001. At September 30, 2001, after the execution of promissory notes
with debtors of certain of the assigned receivables, the original $11 million
loan was comprised of $5.4 million in such executed promissory notes and $5.6
million remaining from the original loan. Consequently, nonaccrual loans at
September 30, 2001 include the $5.4 million in promissory notes as well as the
$5.6 million remaining from the original $11 million loan. Management intends to
appeal the OCC's findings with respect to the $5.4 million, which represents the
substituted debtors. Notwithstanding this intent, management has placed these
loans on nonaccrual status and evaluated them for allowance purposes as of
September 30, 2001 consistent with the OCC's findings. Management believes the
advice received from counsel and the success of its negotiations with debtors
of the assigned receivables are significant factors which should be further
considered by the OCC.
Loans outstanding 90 days or more and still accruing are well secured and in the
process of collection. Approximately $2.5 million consisted of two domestic and
one foreign borrower, that subsequently brought their obligations current, $1.6
million consisted of one foreign borrower that paid the obligation in full
subsequent to quarter end and $5.9 million of three foreign borrowers and is
secured by real estate. Management carefully monitors these loans for any signs
of deterioration.
Management closely evaluated the circumstances relating to the nonperforming
loans as of September 30, 2001, including the availability of collateral and
other sources of repayment, in connection with its assessment of the adequacy of
the allowance for credit losses as of September 30, 2001. The factors management
considers in establishing the amount of the allowance for credit losses are
discussed under "Credit Quality Review." Many of these factors require
management's use of its judgment, assumptions and estimates. Accordingly, there
can be no assurance that the Company's current allowance for credit losses will
prove to be adequate in light of future events and developments.
At September 30, 2001, the Company had $240,000 in nonperforming investment
securities compared to $480,000 at December 31, 2000. This represents a foreign
security that was written down during the first quarter.
DEPOSITS
The primary sources of the Company's domestic time deposits are its eight Bank
branches located in Florida and one in Puerto Rico. In pricing its deposits, the
Company analyzes the market carefully, attempting to price its deposits
competitively with the other financial institutions in the area.
Total deposits were $1.30 billion at September 30, 2001 compared to $1.57
billion at December 31, 2000. The decrease in deposits during the nine month
period was largely in certificates of deposit over $100,000, which decreased by
$160.3 million. Certificates of deposits under $100,000, which represent the
Company's largest category of deposits, declined $34.5 million from $765 million
at December 31, 2000 to $731 million at September 30, 2001. International
banking facility (IBF) deposits decreased by $47.0 million over the nine-month
period, and other non-time deposits decreased by $27.2 million.
In connection with steps taken to comply with required regulatory capital
ratios, including a reduction in total loans outstanding, the Bank has reduced
its funding requirements during 2001. The lower funding requirements have
allowed the Bank to reduce the rates offered on its renewing time deposits,
compared to rates offered by competing depository institutions. The lower level
of lending activity in 2001 compared to 2000 also contributed to the decline in
IBF deposits, which generally are placed by foreign banks, in part, in
connection with their lending activity with the Bank. To a lesser extent, each
of the deposit categories have been impacted by declines in the Bank's
investment ratings. As a result, total deposits have declined and are expected
to continue declining for the foreseeable future.
The following table indicates the maturities and amounts of certificates of
deposit and other time deposits issued in denominations of $100,000 or more as
of September 30, 2001:
23
MATURITIES OF AND AMOUNTS OF CERTIFICATES OF DEPOSIT AND OTHER TIME DEPOSITS
$100,000 OR MORE
(in thousands)
Certificates of Deposit Other Time Deposits
$100,000 or More $100,000 or More Total
---------------------- ------------------- ---------
Three months or less $ 76,616 $ 255 $ 76,871
Over 3 through 6 months 98,797 728 99,525
Over 6 through 12 months 120,768 812 121,580
Over 12 months 56,737 -- 56,737
--------- ------- ---------
Total $ 352,918 $ 1,795 $ 354,713
========= ======= =========
STOCKHOLDERS' EQUITY
The Company's stockholders' equity at September 30, 2001 declined to $74.8
million compared to $102.5 million at December 31, 2000, primarily as a result
of the net loss of $28.3 million recorded for the nine months ended September
30, 2001. See CAPITAL RESOURCES, REGULATORY MATTERS, GOING CONCERN AND DIVIDEND
RESTRICTIONS for additional discussion of capital resources.
24
INTEREST RATE SENSITIVITY
The following table presents the projected maturities or interest rate
adjustments of the Company's earning assets and interest-bearing funding sources
based upon the contractual maturities or adjustment dates at September 30, 2001.
The interest-earning assets and interest-bearing liabilities of the Company and
the related interest rate sensitivity gap given in the following table may not
be reflective of positions in subsequent periods.
INTEREST RATE SENSITIVITY REPORT
(Dollars in thousands)
----------------------------------------------------------------------------------------
0 to 30 31 to 90 91 to 180 181 to 365 1 to 5 Over 5
Days Days Days Days Years Years Total
----------------------------------------------------------------------------------------
Earning Assets:
Loans $567,256 $111,658 $ 94,715 $ 24,208 $120,597 $ 43,399 961,833
Federal funds sold 38,805 -- -- -- -- -- 38,805
Investment securities 160,912 146,714 1,730 3,498 17,074 12,518 342,446
Interest earning deposits with
other banks 7,700 3,500 9,075 6,000 100 -- 26,375
----------------------------------------------------------------------------------------
Total 774,673 261,872 105,520 33,706 137,771 55,917 1,369,459
----------------------------------------------------------------------------------------
Funding Sources:
Savings and transaction deposits 46,990 86,811 -- -- -- -- 133,801
Certificates of deposits of $100K
or more 23,369 53,248 98,796 120,768 56,737 -- 352,918
Certificates of deposits under $100K 43,897 79,992 210,749 261,990 121,042 88 717,758
Other time deposits IBF 255 -- 728 812 -- -- 1,795
Funds overnight/Securities Repos 20,400 -- -- -- -- -- 20,400
Trust preferred -- -- -- -- -- 12,650 12,650
----------------------------------------------------------------------------------------
Total $134,911 $220,051 $ 310,273 $ 383,570 $177,779 $ 12,738 $1,239,322
========================================================================================
Interest sensitivity gap $639,762 $ 41,821 $(204,753) $(349,864) $(40,008) $ 43,179 $ 130,137
========================================================================================
Cumulative gap $639,762 $681,583 $ 476,830 $ 126,966 $ 86,958 $130,137
=========================================================================
Cumulative gap as a percentage
of total earning assets 46.72% 49.77% 34.82% 9.27% 6.35% 9.50%
=========================================================================
At September 30, 2001, the Company had assets repricing within 30 days in excess
of liabilities repricing within 30 days of $640 million. This is known as a
"positive gap" position. For the period extending 180 days after September 30,
2001, the cumulative positive gap position was $477 million. In a declining rate
environment, a positive gap position normally results in declining net interest
income as assets are re-priced at lower rates more quickly than liabilities. The
Company has experienced this condition during the first nine months of 2001, and
expects to continue to experience declines in net interest income for the
remainder of 2001 as a result of its gap position.
25
LIQUIDITY
Cash and cash equivalents decreased by $75.6 million from December 31, 2000 to
September 30, 2001, reflecting the use of available funds to purchase investment
securities. During the first nine months of 2001, net cash provided by operating
activities was $12.1 million, net cash provided by investing activities was
$196.4 million and net cash used in financing activities was $284.1 million.
Cash was provided primarily by repayments and sales of loans, and was used
primarily to acquire investment securities and repay maturing time deposits. For
further information on cash flows, see the Consolidated Statement of Cash Flows.
The Company's principal sources of liquidity and funding are its deposit base,
scheduled repayments of loans and the sale of bankers' acceptances as well as
loan participations. The level and maturity of deposits necessary to support the
Company's lending and investment activities is determined through monitoring
loan demand and through its asset/liability management process. Considerations
in managing the Company's liquidity position include, but are not limited to,
scheduled cash flows from existing assets, contingencies and liabilities, as
well as projected liquidity needs arising from anticipated extensions of credit.
Furthermore the liquidity position is monitored daily by management to maintain
a level of liquidity conducive to efficient operations and is continuously
evaluated as part of the asset/liability management process.
The short-term nature of the loan portfolio and the fact that a portion of the
loan portfolio consists of bankers' acceptances provides additional liquidity to
the Company. Liquid assets at September 30, 2001 were $340.6 million, 24 percent
of total assets, and consisted of cash and cash equivalents, interest earning
deposits in other banks and available for sale investment securities maturing
within one year or less that are unpledged.
Liquidity is also necessary at the Bancorp, parent company only, level.
Traditionally, the liquidity needs of Bancorp have been met by dividends
received from the Bank, or by proceeds from the issuance of securities in
capital markets. As discussed below in REGULATORY MATTERS, the Bank is currently
prohibited from paying any dividends without prior regulatory approval, and any
such approval is unlikely to be granted. Furthermore, in light of the financial
condition of the Company, it is unlikely that access to capital markets for the
issuance of public securities is available to the Company. In connection with
the engagement of CIBC World Markets as its investment banker, the Company is
exploring access to private capital markets.
At September 30, 2001. Bancorp had available cash of approximately $545,000.
Based on historic cash needs, cash available at September 30, 2001 was adequate
to meet projected cash needs into the first quarter of 2002. Management is
currently reviewing alternative cash sources as well as the projected uses of
cash to maximize available liquidity and provide for liquidity needs beyond the
first quarter of 2002. At the current time, the success of these efforts cannot
be predicted.
CAPITAL RESOURCES, REGULATORY MATTERS, GOING CONCERN AND DIVIDEND RESTRICTIONS
REGULATORY MATTERS - The Office of the Comptroller of the Currency ("OCC") is
currently in the final stages of conducting a safety and soundness examination
of the Bank. The Bank believes the examination will be completed in the fourth
quarter of 2001 and an examination report delivered to the Bank. In connection
with this examination, in September 2001 the OCC advised the Bank of preliminary
findings that the Bank may need to increase its allowance for loan losses
reported in the Bank's Call Report as of June 30, 2001 by up to $12.0 million.
Recently this amount was changed to $11 million. The potential increase in the
allowance resulting from the OCC's preliminary findings include approximately
$7.0 million attributable to differences in loan grades assigned by the OCC and
the Bank, and approximately $4.0 million attributable to changes in the
methodology employed to estimate the allowance for non-graded loans. Although
the OCC has not issued its written report containing the final proposed
adjustments, the Bank has communicated to the OCC its intent to appeal these
findings as to the amount of any additional allowance and the period in which
any additional allowance should be recorded. Pending the conclusion of the
examination and associated appeal process, the Bank has included approximately
$4.2 million in the provision for loan losses for the three months ended
September 30, 2001 as a result of loan classifications assigned by the OCC. In
addition, as of September 30, 2001, the Bank revised certain processes used in
estimating the allowance for loan losses to reflect findings communicated by the
OCC. Management believes the actions taken in the third quarter incorporate the
preliminary findings of the OCC in the determination of the allowance for loan
losses as of September 30, 2001, in all material respects.
Should the Bank be required to amend its June 30, 2001 Call Report as a result
of the matter discussed above, the Company will also amend its consolidated
financial statements included in Form 10-Q for the quarter ended June 30, 2001.
Furthermore, the consolidated financial statements included in this Form 10-Q
for the quarter ended September 30, 2001 would be amended to reduce the
provision for loan losses recorded in the third quarter of 2001 due to the
increased provision recorded in the second quarter of 2001. The estimated effect
of any such amendment would be to increase the consolidated net loss reported
for the quarter ended June 30, 2001 by up to $11.0 million, from $24.7 million
($2.45 per share) to $35.7 million ($3.54 per share). The net loss for the
quarter ended September 30, 2001 of $6.2 million ($.61 per share) would change
to estimated net income of $5.0 million ($.50 per share).
In April 2001, the Compensation Committee of the Board of Directors of the
Company, after consultation with legal counsel, resolved to terminate the
position of several senior officers under and in accordance with their
employment agreements with the Company. The Compensation Committee decided that
the first such senior officer to be terminated would be a former executive
officer who is also the spouse of the chief executive officer of the Company and
the Bank. In connection with the termination, the Bank paid approximately
$592,000 to the executive pursuant to the terms of the contract regarding
termination without cause. The chief executive officer is not a member of the
Compensation Committee and therefore he did not vote on this matter. Subsequent
to the payment, the OCC advised the Bank that a prior application to the OCC and
the Federal Deposit Insurance Corporation ("FDIC") was required due to the
Bank's troubled condition. Because no such prior application was made to and
approved by the OCC and the FDIC, the OCC and the FDIC further advised the Bank
that the severance payment was prohibited under Federal banking regulations. The
Bank subsequently made such an application for the above mentioned officers,
which was denied by the OCC and the FDIC in September 2001. The OCC and the FDIC
have directed the Board of Directors of the Bank to cause restitution to be made
to the Bank. The Board is negotiating with the former executive officer to cause
restitution to be made to the Bank, but there is no assurance that such
negotiations will be successful. If unsuccessful, the OCC has advised the Board
that it expects the Board to take appropriate actions to cause restitution to be
made. At this time, management is unable to predict the ultimate resolution of
this matter or the impact this matter will have on the Company or the Bank.
Insured depository institutions and their holding companies must meet applicable
capital guidelines or be subject to a variety of enforcement remedies, including
dividend restrictions, the issuance of capital directives, the issuance of cease
and desist orders, the imposition of civil money penalties, the termination of
deposit insurance by the FDIC or the appointment of a conservator or receiver.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Bank must meet specific capital guidelines that involve
quantitative measures of the Bank's assets, liabilities, and certain off-balance
sheet items as calculated under regulatory accounting practices. The Bank's
capital amounts and classification are also subject to qualitative judgments by
the regulators about components, risk weightings, and other factors.
26
The Company is subject to risk-based capital and leverage guidelines issued by
the Board of Governors of the Federal Reserve System and the Bank is subject to
similar guidelines issued by the OCC. These guidelines are used to evaluate
capital adequacy and include the required minimums shown in the following table.
To be "adequately capitalized" under federal bank regulatory agency definitions,
a depository institution must have a Tier 1 ratio of at least 4%, a total ratio
of at least 8% and a leverage ratio of at least 4%. As of September 30, 2001,
the Bank's capital ratios did not meet all of these minimum percentages.
Furthermore, as discussed below, the Bank is subject to a written agreement to
maintain specific capital levels in excess of minimum requirements. As of
December 31, 2000 and September 30, 2001 the Bank was not in compliance with
this agreement. Furthermore, as discussed below, in June 2001, the OCC
reclassified the Bank's capital category for certain regulatory purposes to
"undercapitalized." The regulatory agencies are required by law to take specific
prompt actions with respect to institutions that do not meet minimum capital
standards.
In February 2000, the OCC initiated a formal administrative action against the
Bank alleging various unsafe and unsound practices discovered through an
examination of the Bank as of August 23, 1999. On September 8, 2000, the OCC and
the Bank settled the administrative action by entering into a cease and desist
order by consent (the "September 8 Order"). The September 8 Order required the
Bank to comply with, among other things, certain accounting and capital
requirements and to make specified reports and filings. Further, pursuant to the
September 8 Order, the Bank may declare a dividend only if it is in compliance
with the capital levels required by the order and has obtained the prior written
approval of the OCC. The September 8 Order also required the Bank to maintain by
September 30, 2000 Tier 1, Total and leverage capital ratios of 10%, 12% and 7%,
respectively. As of December 31, 2000 and September 30, 2001, the Bank had Tier
1, Total and leverage capital ratios of 9.4%, 10.7% and 6.5%, respectively, and
6.3%,7.6% and 4.5%, respectively. As a result, the Bank was not in compliance
with the capital requirements of the September 8 Order as reflected in the
following table. Failure of the Bank to comply with the terms of the September 8
Order could result in the assessment of civil money penalties, the issuance of
an order by a District Court requiring compliance with the September 8 Order,
the placing of restrictions on the source of deposits or, in certain
circumstances, the appointment of a conservator or receiver. In addition, the
FDIC may initiate a termination of insurance proceeding where there has been a
violation of an order.
BANCORP CAPITAL RATIOS
(Dollars in thousands)
September 30, 2001 December 31, 2000
------------------------ --------------------------
Amount Ratio Amount Ratio
------------------------ --------------------------
Tier 1 risk-weighted
Capital
Actual $ 66,636 6.4% $ 114,119 9.8%
Minimum 41,878 4.0% 46,657 4.0%
Total risk-weighted
Capital
Actual 80,203 7.7% 129,503 11.1%
Minimum 83,757 8.0% 93,314 8.0%
Tier 1 capital (to average assets):
Actual 66,636 4.5% 114,119 6.7%
Minimum 44,266 3.0% 51,468 3.0%
27
BANK CAPITAL RATIOS
(Dollars in thousands)
September 30, 2001 December 31, 2000
-------------------------- --------------------------
Amount Ratio Amount Ratio
-------------------------- --------------------------
Tier 1 risk-weighted capital
Actual $ 65,347 6.3% $ 111,340 9.4%
Minimum required by OCC Consent Order 104,517 10.0% 118,914 10.0%
Minimum to be well capitalized 62,710 6.0% 71,358 6.0%
Minimum to be adequately capitalized 41,807 4.0% 47,566 4.0%
Total risk-weighted capital:
Actual 79,892 7.6% 127,004 10.7%
Minimum required by OCC Consent Order 125,421 12.0% 142,697 12.0%
Minimum to be well capitalized 104,517 10.0% 118,914 10.0%
Minimum to be adequately capitalized 83,614 8.0% 95,131 8.0%
Leverage
Actual 66,336 4.5% 111,340 6.5%
Minimum required by OCC Consent Order 103,179 7.0% 120,114 7.0%
Minimum to be well capitalized 73,699 5.0% 85,796 5.0%
Minimum to be adequately capitalized 58,959 4.0% 68,637 4.0%
On March 28, 2001, the OCC issued a Notice of Charges for Issuance of an Amended
Order to Cease and Desist (the "Notice of Charges") against the Bank. The Notice
of Charges alleged that the Bank has violated certain federal banking laws and
regulations by, among other things, (i) making loans in violation of applicable
lending limits; (ii) failing to file accurate Call Reports; (iii) failing to
file Suspicious Activity Reports ("SARs") with respect to certain transactions;
(iv) failing to provide a system of internal controls to ensure ongoing
compliance with the Bank Secrecy Act (the "BSA") and (v) engaging in unsafe and
unsound practices. The Notice of Charges also alleged that the Bank has violated
the September 8 Order by approving certain overdrafts and making certain loans,
and has not complied with certain other provisions of the September 8 Order.
Under the Notice of Charges, the OCC seeks the issuance of an Amended Order to
Cease and Desist (the "Proposed Amended Order").
In connection with the issuance of the Notice of Charges, the OCC issued a
Temporary Order to Cease and Desist (the "Temporary Order") also on March 28,
2001. The Temporary Order requires the Bank to, among other things, (i) comply
with specified internal procedures in connection with the making of loans and
overdrafts and the placement of funds; (ii) develop, implement and adhere to a
written program acceptable to the OCC to ensure compliance with the BSA; (iii)
comply with specified procedures with respect to pouches received by the Bank
and existing foreign correspondent accounts; and (iv) develop, implement and
adhere to a written program acceptable to the OCC to ensure compliance with the
requirements to file SARs. In addition, the Temporary Order prohibits the Bank
from engaging in transactions with certain named persons and entities, or with
any parties who provide funding to such persons and entities.
The Proposed Amended Order contains provisions that are substantially the same
as those contained in the Temporary Order, as well as additional requirements.
The additional provisions contained in the Proposed Amended Order would also
require the Bank to, among other things, (i) achieve and maintain Tier 1, Total
and leverage capital ratios of 12%, 14% and 9%, respectively; (ii) develop,
implement and adhere to a three year capital plan acceptable to the OCC; and
(iii) obtain the approval of the OCC with respect to the appointment of new
directors and senior officers.
By letter dated March 28, 2001 (the "PCA Notice"), the OCC notified the Company
of its intent to "reclassify" the capital category of the Bank to
"undercapitalized" for purposes of Prompt Corrective Action ("PCA") based on the
OCC's determination that the Bank is engaging in unsafe and unsound banking
practices. On June 13, 2001, following an informal hearing on the OCC's intent
to reclassify, the Bank was notified that the OCC rendered a decision and
reclassified the Bank's capital category to "undercapitalized" for purposes of
PCA. Prior to this reclassification the Bank's capital category for PCA was
"adequately capitalized." As a result of the reclassification, the
28
Bank is subject to restrictions on its ability to pay dividends and management
fees, and restrictions on asset growth and expansion. Under the September 8
Order, the Bank was previously required to obtain prior approval from the OCC
for the payment of any dividends. Additionally, the Bank's waiver from the
FDIC authorizing it to accept brokered deposits is no longer applicable, and a
new waiver must be obtained from the FDIC prior to the acceptance or renewal of
any brokered deposits subsequent to the date of the reclassification. As of
September 30, 2001, the Bank held $10 million of brokered deposits, the
acquisition of which was initiated in the normal course of business on June 6,
2001, prior to receipt of the notification from the OCC, but which were
accepted by the Bank after the notification was received from the OCC. By
letter dated June 28, 2001, the FDIC informed the Bank that receipt of these
deposits were apparent violations of regulations regarding brokered deposits.
As of November 13, 2001, the Bank has received no further communication from
the FDIC on this matter. These deposits will mature on December 17, 2001, at
which time the Bank expects to repay them in the normal course of business.
Under PCA, the OCC may impose additional discretionary restrictions by the
issuance of a PCA directive, and after the opportunity for a hearing, if the OCC
determines that such actions are necessary to help resolve the problems of the
Bank at the least possible long term cost to the FDIC. Such additional
discretionary restrictions include requiring recapitalization, restricting
transactions with affiliates, restricting interest rates paid, further
restricting asset growth, restricting activities, improving management and the
board by requiring new members or dismissal of existing members, prohibiting
deposits from correspondent banks, requiring divestiture of subsidiaries of the
Bank (currently the Bank has no subsidiaries) and any other actions the OCC
determines will better resolve the problems of the Bank at the least possible
long term cost to the deposit insurance fund. Additionally, the Federal Reserve
Board (the "FRB") may impose restrictions including requiring prior approval of
the FRB for any capital distributions by the Company (the FRB has notified the
Company that prior approval is required for any such distributions), requiring
divestiture of any affiliate other than an insured depository institution and
requiring divestiture of the Bank if the FRB determines that divestiture would
improve the Bank's financial condition and future prospects.
GOING CONCERN -- The accompanying consolidated financial statements have been
prepared on a going concern basis, which contemplates the realization of assets
and the satisfaction of liabilities in the normal course of business. The
matters discussed above and the uncertainty of what actions the regulators might
take related to them raise substantial doubt about the Company's ability to
continue as a going concern. The consolidated financial statements do not
include the adjustments, if any, that might have been required had the outcome
of the above mentioned uncertainties been known, or any adjustments relating to
the recoverability of recorded asset amounts or the amounts of liabilities that
may be necessary should the Company be unable to continue as a going concern.
Management of the Company believes the Company has several means by which to
achieve compliance with the prescribed capital requirements of the September 8
Order. Such plans initially provide for reducing the Bank's size through
selected asset run-off; the sale of credit risk which effectively decreases the
Bank's regulatory capital requirements; targeted loan sales, including the sale
of the Ecuador portfolio subject to ATRR, and loan participations to other
banks; and shifting assets to liquid investments which decreases regulatory
capital requirements. In addition to the ongoing efforts to bring the Bank into
compliance with the capital requirements of the September 8 Order, the Bank has
taken comprehensive actions to address the matters that have been identified by
the OCC and are subject of the various administrative enforcement proceedings
described herein. Among other things, the Bank has hired a chief financial
officer, enhanced its policies and procedures, conducted extensive Bank Secrecy
Act training, revised its capital plan to include recommendations contained in
the report of examination received in February 2001, enhanced its credit
analysis function and reduced exposure in emerging markets. Management has
submitted a revised business and capital plan to the OCC to take into
consideration the operating results for the period ended September 30, 2001. The
company also appointed a chief operating officer, who subsequently resigned,
effective September 30, 2001.
In addition, in June 2001, the Company engaged CIBC World Markets, an investment
bank, to advise the Company in exploring and evaluating strategic alternatives
to enhance shareholder value. Such alternatives could include but are not
limited to a possible sale or other transfer of all or a significant portion of
the assets or securities of the Company or some other corporate transaction
involving a change in control of the Company. There is no assurance that any of
the foregoing transactions will be consummated.
Further, management of the Company does not believe that the ratios in the
Proposed Amended Order are appropriate or warranted and Management does not
intend to agree to such ratios voluntarily. In addition, Management believes the
timeframes for achieving such ratios set forth in the Proposed Amended Order are
commercially unreasonable.
29
However, assuming that the ratios were in fact lawfully imposed and that the
Bank was given a reasonable time to achieve such ratios, management believes and
anticipates that the Bank would continue to take the actions outlined above in
an orderly manner to meet required ratios.
The Company's continuation as a going concern is dependent on (i) the Bank's
ability to comply with the terms of regulatory orders and its prescribed capital
requirements and (ii) the severity of the actions that might be taken by
regulators as a result of non-compliance. However, there can be no assurance
that the Bank will be able to comply with such terms and achieve these
objectives.
DIVIDEND RESTRICTIONS -- On March 30, 2001, the Company was advised by the
Federal Reserve Bank of Atlanta (the "FRB"), its primary regulator, that the
Company and Hamilton Capital Trust I should not pay any dividends, distributions
or debt payments without the prior approval of the FRB. The Company obtained
approval from the FRB to pay the dividend payable on April 2, 2001, amounting to
approximately $309,000, on the Series A Beneficial Unsecured Securities (the
"Trust Preferred Securities") issued by Hamilton Capital Trust I (the "Trust").
There can be no assurance that the FRB will approve any future payments. The
Company will not seek such approval and will not pay dividends on the Trust
Preferred until the Company's financial condition improves. Pursuant to the
documents governing the Trust Preferred Securities, the Company and the Trust
have the right, under certain conditions, to defer dividend payments for up to
20 consecutive quarters. Any payments deferred in this manner will continue to
accumulate. Pursuant to this right, the Company and the Trust have deferred
payment of the dividend otherwise payable on July 2, 2001 and each quarterly
period thereafter and, until further notice, expect to defer future payments. As
of September 30, 2001, accumulated deferred dividends amounted to approximately
$618,000.
MARKET RISK MANAGEMENT
In the normal course of conducting business activities, the Company is exposed
to market risk that includes both price and liquidity risk. The Company's price
risk arises from fluctuations in interest rates and foreign exchange rates that
may result in changes in values of financial instruments. The Company does not
have material direct market risk related to commodity and equity prices.
Liquidity risk arises from the possibility that the Company may not be able to
satisfy current and future financial commitments or that the Company may not be
able to liquidate financial instruments at market prices. Risk management
policies and procedures have been established and are utilized to manage the
Company's"exposure to market risk. The strategy of the Company is to operate at
an acceptable risk environment while maximizing its earnings.
Market risk is managed by the Asset Liability Committee that formulates and
monitors the performance of the Company based on established levels of market
risk as dictated by policy. In setting the tolerance levels of market risk, the
Committee considers the impact on both earnings and capital, based on potential
changes in the outlook in market rates, global and regional economies,
liquidity, business strategies and other factors.
The Company's" asset and liability management process is utilized to manage
interest rate risk through the structuring of balance sheet and off-balance
sheet portfolios. It is the strategy of the Company to maintain as neutral an
interest rate risk position as possible. By utilizing this strategy, the Company
"locks in" a spread between interest earning assets and interest-bearing
liabilities. However, since the Company has traditionally funded its assets with
fixed rated time deposits, significant changes in market interest rates in a
short period of time could have a material impact on the Company's net interest
income. Given the matching strategy of the Company and the fact that it does not
maintain significant medium and/or long-term exposure positions, the
Company's"interest rate risk will be measured and quantified through an interest
rate sensitivity report. An excess of assets or liabilities over these matched
items results in a gap or mismatch. A positive gap denotes asset sensitivity and
normally means that an increase in interest rates would have a positive effect
on net interest income, while a decline in interest rates would have a negative
effect on net interest income. On the other hand, a negative gap denotes
liability sensitivity and normally means that a decline in interest rates would
have a positive effect on net interest income, while an increase in interest
rates would have a negative effect on net interest income. However, because
different types of assets and liabilities with similar maturities may reprice at
different rates or may otherwise react differently to changes in overall market
rates or conditions, changes in prevailing interest rates may not necessarily
have such effects on net interest income.
The level of imbalance between the repricing of rate sensitive assets and rate
sensitive liabilities will be measured through a series of ratios. Substantially
all of the Company's"assets and liabilities are denominated in dollars,
therefore the Company has no material foreign exchange risk. In addition, the
Company has no trading account securities, therefore it is not exposed to market
risk resulting from trading activities.
30
RESULTS OF OPERATIONS-NINE MONTHS
NET INTEREST INCOME
Net interest income is the difference between interest and fees earned on loans
and investments and interest paid on deposits and other sources of funds. It
constitutes the Company's principal source of income. Net interest income
decreased to $25.1 million for the nine months ended September 30, 2001 from
$49.3 million for the same period in 2000, a 49.1 percent decrease. The decrease
was due largely to a decrease in the net interest margin resulting from a lower
yield on earning assets, and a higher cost of interest bearing liabilities. Net
interest margin decreased to 2.09 percent for the nine months ended September
30, 2001 from 3.99 percent for the same period in 2000, a 190 basis point
decrease.
The average yield on loans, which represents the Company's largest component of
earning assets, declined from 9.72% in 2000 to 8.47% in 2001, primarily due to
lower market rates and a higher level of nonaccrual assets. The yield on
investments and time deposits with banks declined from 8.09% to 5.50%, also due
to lower market rates. Also, a greater portion of this component was held in
investment securities in lieu of higher yielding time deposits in connection
with capital ratio management strategies as a result of regulatory requirements.
The overall yield on earning assets declined from 9.25% to 7.68%. Average
earning assets decreased to $1.590 billion for the nine months ended September
30, 2001 from $1.632 billion for the same period in 2000, a 3.0 percent
decrease. Average loans and acceptances discounted were relatively unchanged at
$1.168 billion for the nine months ended September 30, 2001 and $1.167 billion
for the same period in 2000. During the second and third quarters of 2001, loans
have been on a declining trend and average loans for the fourth quarter and full
year of 2001 are expected to be lower than the comparable periods of 2000.
Interest income decreased to $92.5 million for the nine months ended September
30, 2001 from $114.6 million for the same period in 2000, a 19.2 percent
decrease.
The average rate of interest bearing liabilities increased from 5.92% for the
nine months ended September 30, 2000 to 6.30% for the comparable period of 2001.
The increase reflects the impact of certificates of deposits acquired primarily
in the second and third quarters of 2000 at rates ranging from 6-7%, for terms
of 24 months and greater. As a percentage of average earning assets, interest
cost increased from 5.27% in 2000 to 5.59% in 2001. Interest expense increased
to $67.2 million for the nine months ended September 30, 2001 from $65.2 million
for the same period in 2000, a 3.0 percent increase. Average interest-bearing
liabilities decreased to $1.412 billion for the nine months ended September 30,
2001 from $1.453 billion for the same period in 2000, a 2.9 percent decrease.
31
YIELDS EARNED AND RATE PAID
- -------------------------------------------------------------------------------------------------------------------------------
FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 2001 SEPTEMBER 30, 2000
------------------------------ -------------------------------
AVERAGE REVENUE/ YIELD/ AVERAGE REVENUE/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
---------- -------- ------ ---------- -------- ------
Total Earning Assets
LOANS:
Commercial loans $ 903,024 $56,375 8.26% $1,037,639 $ 75,896 9.65%
Commercial real estate loans 129,003 8,182 8.39% 5,354 392 9.65%
Acceptances Discounted 128,968 9,194 9.44% 114,013 8,422 9.74%
Overdraft 5,402 866 21.22% 8,389 1,199 18.85%
Mortgage loans 1,712 101 7.81% 2,086 126 7.97%
---------- ------- ----- ---------- -------- -----
TOTAL LOANS 1,168,109 74,718 8.47% 1,167,481 86,035 9.72%
---------- ------- ----- ---------- -------- -----
Time Deposit with Banks 55,821 3,527 8.36% 143,042 10,162 9.37%
Investments 306,157 12,075 5.22% 273,235 16,107 7.77%
Federal funds sold 60,082 1,927 4.24% 48,515 2,249 6.11%
---------- ------- ----- ---------- -------- -----
Total Investments and Time Deposit
with Banks 422,060 17,529 5.50% 464,792 28,518 8.09%
---------- ------- ----- ---------- -------- -----
Total Interest Earning assets 1,590,169 92,247 7.68% 1,632,273 114,553 9.25%
------- ----- -------- -----
Total non interest earning assets 31,003 70,269
---------- ----------
TOTAL ASSETS $1,621,172 $1,702,542
========== ==========
Interest Bearing Liabilities
DEPOSITS:
NOW and savings accounts $ 20,098 352 2.32% $ 21,660 400 2.44%
Money Market 46,441 1,678 4.78% 44,650 2,008 5.93%
Presidential Money Market 67,950 2,333 4.54% 69,427 2,961 5.62%
Certificate of Deposits (including IRA) 1,219,134 60,477 6.57% 1,203,968 54,628 5.98%
Time Deposits from Banks (IBF) 39,911 1,219 4.04% 84,671 3,611 5.62%
---------- ------- ----- ---------- -------- -----
TOTAL DEPOSITS 1,393,534 66,059 6.27% 1,424,376 63,608 5.89%
Trust preferred securities 12,650 925 9.75% 12,650 925 9.75%
Securities sold under agreements to repurchase 5,423 190 4.64% 16,372 686 5.53%
Federal Funds Purchased 37 1 5.06% 47 2 5.61%
---------- ------- ----- ---------- -------- -----
Total interest bearing liabilities 1,411,644 67,175 6.30% 1,453,445 65,221 5.92%
---------- ------- ----- ---------- -------- -----
Non interest bearing liabilities
Demand Deposits 80,341 76,547
Other Liabilities 35,137 56,670
---------- ----------
Total non interest bearing liabilities 115,478 133,217
---------- ----------
Stockholders' equity 94,050 115,880
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,621,172 $1,702,542
========== ==========
Net Interest income / net interest spread $25,072 1.38% $ 49,332 3.34%
======= ===== ======== =====
Margin
Interest income / interest earning assets 7.68% 9.25%
Interest expense / interest earning assets 5.59% 5.27%
-------- -----
Net interest margin 2.09% 3.99%
======== -====
32
PROVISIONS FOR CREDIT LOSSES AND TRANSFER RISK
The Company's provision for credit losses increased to $48.6 million for the
nine months ended September 30, 2001 from $33.2 million for the same period in
2000. During the second quarter of 2001, management assessed the collection
probabilities of loans previously placed on nonaccrual status and determined to
charge off approximately $20.4 million of such loans, resulting in a need to
increase the allowance for loan losses related to these loans by approximately
$9.7 million during the second quarter. Additionally, the circumstances of
approximately $13.3 million in loans previously not on nonaccrual status changed
significantly, leading to a determination to charge these items off. These
charges-offs required an addition to the allowance of approximately $11.5
million. During the second and third quarters of 2001, aggregate provisions of
approximately $24.6 million were recorded based on the evaluation of
problem-graded assets as of the respective period ends and in consideration of
preliminary examination findings received from the OCC. Management has indicated
to the OCC its intent to appeal certain of these findings. See "Regulatory
Matters" and "Nonperforming Assets" above. The provision for the periods
represents the amount management deemed necessary to maintain the allowance for
credit losses at an adequate level. In establishing the amount of provision for
credit losses, management considers various factors, as discussed under "Credit
Quality Review."
For the nine months ended September 30, 2001, the Company recovered allocated
transfer risk reserves of $11.1 million, compared to a provision for transfer
risk of $8.4 million for the nine months ended September 30, 2000. The recovery
results primarily from the sale in the third quarter of 2001 of approximately
$32.3 million of assets subject to a 90% ATRR requirement for cash proceeds of
approximately $18.7 million. The gross ATRR recovery of approximately $15.5
million was partly offset by assets that became subject to ATRR provisions in
2001. The provision in 2000 reflects the net amount of assets that became
subject to ATRR during the period ended September 30, 2000.
See "Credit Quality Review" for more discussion of the allowance for credit
losses and ATRR.
NON-INTEREST INCOME
Non-interest income decreased from $11.5 million for the nine months ended
September 30, 2000 to $6.3 million for the same period in 2001. The 2001 period
included the write off of an equity investment in a foreign bank of $1.2 million
due to a deteriorating trend in the financial condition of the investee bank.
During the first nine months of 2000, the Company recognized investment gains of
$2.7 million. This change in the results of securities transactions accounts for
the majority of the decrease in non-interest income.
The following table sets forth details regarding the components of non-interest
income for the periods indicated.
NON-INTEREST INCOME
(Dollars in thousands)
For the Nine Months Ended September 30,
---------------------------------------------
2001 to 2000
2001 Percent Change 2000
-------- -------------- ---------
Trade finance fees and commissions $ 4,923 -20.2% $ 6,167
Customer service fees 1,081 -10.8% 1,212
Gain (loss) on securities transactions (773) -120.3% 3,808
Other 1,100 259.5% 306
-------- ------- ---------
Total non-interest income $ 6,331 -44.9% $ 11,493
======== ======= =========
OPERATING EXPENSES
Operating expenses increased to $32.2 million for the nine months ended
September 30, 2001 from $30.3 million for the same period in 2000, a 6.0 percent
increase. Employee compensation and benefits increased approximately 19.3
percent due to new staff, primarily at the management level and related to the
development of the Company's domestic business. The 2001 period also includes
approximately $592,000 in severance costs related to the termination of the
employment agreement with a former executive, who is also the spouse of the
chief executive officer of the Company. Legal expenses increased 99.3% in 2001
compared to 2000, reflecting costs incurred relating to litigation and
regulatory matters. Audit and examination costs increased approximately 255
percent due to costs incurred to address regulatory and financial reporting
matters. Additionally, as a result of supervisory concern, the Bank's
33
risk category dropped for deposit insurance purposes resulting in higher deposit
insurance assessments. The Company's efficiency ratio increased to 83.3 percent
for the nine month period ended September 30, 2001 from 41.2 percent for the
same period in 2000.
The following table sets forth details regarding the components of operating
expenses for the periods indicated.
OPERATING EXPENSES
(Dollars in thousands)
For the Nine Months Ended September 30,
----------------------------------------------
2001 to 2000
2001 Percent Change 2000
--------- -------------- ---------
Employee compensation and benefits $ 12,088 19.3% $ 10,132
Occupancy and equipment 3,484 -5.1% 3,670
Legal Expenses 3,822 99.3% 1,918
Litigation Reserves -- -100.0% 4,524
Audit and Examination 2,175 255.4% 612
FDIC Insurance 2,079 96.1% 1,060
Other losses & charge-offs 3,270 30.9% 2,498
Other operating expenses 5,232 17.2% 5,930
--------- ------- ---------
Total operating expenses $ 32,150 5.9% $ 30,344
========= ======= =========
QUARTER OVERVIEW
The Company's operating results for the three months ended September 30, 2001
compared to the three months ended September 30, 2000 were primarily influenced
by the provision for credit losses recorded in 2000, the recovery of $14.2
million of ATRR in 2001, and lower net interest income in 2001. For the 2001
period the provision for credit losses was $15.6 million, compared to $32.5
million for 2000. In addition, trends in net interest income for the nine months
ended September 30, 2001, as discussed above, were also applicable to the
three-month period. Primarily as a result of these factors, the Company reported
a consolidated net loss of $6.2 million for the three months ended September 30,
2001, compared to a net loss of $17.9 million in 2000.
RESULTS OF OPERATIONS - THIRD QUARTER
Net interest income decreased to $4.5 million for the quarter ended September
30, 2001 from $16.4 million for the same period in 2000, a 72.5 percent
decrease. This decrease was due primarily to the drop in net interest margin,
which decreased by 273 basis points to 1.23 percent for the quarter ended
September 30, 2001, from 3.96 percent for the same period in 2000.
Average earning assets decreased 11.2 percent to $1.455 billion, from $1.639
billion for the same period in 2000. Average loans decreased to $1.043 billion
from $1.138 billion for the same period in 2000, and the rate earned on loans
decreased 244 basis points due to lower market rates and the increased level of
nonaccruing loans discussed earlier. Average investments and time deposits with
banks decreased by approximately $88.8 million to $412.0 million. The rate
earned on investments and time deposits with banks decreased by 388 basis points
due to the decline in market rates and as the Company has turned more to
domestic, lower yielding investments in lieu of foreign bank time deposits and
placements. Interest income decreased to $24.6 million for the quarter ended
September 30, 2001 from $39.4 for the same period in 2000, a 37.4 percent
decrease.
Interest expense decreased to $20.1 million, a decrease of 12.4 percent when
compared to the same period in 2000. Average interest bearing liabilities
decreased by 10.0 percent to $1.310 billion when compared to the same period in
2000. This decrease occurred primarily in securities sold under agreement to
repurchase, which the Bank discontinued offering in the third quarter of 2001,
and, to a lesser extent, in certificates of deposit. In addition, the yield paid
on interest bearing liabilities decreased slightly by 17 basis points to 6.07
percent for the three months ended September 30, 2001 when compared to the same
period in 2000.
34
YIELDS EARNED AND RATE PAID
- --------------------------------------------------------------------------------------------------------------------------------
For The Quarter Ended
-------------------------------------------------------------------
September 30, 2001 September 30, 2000
------------------------------ --------------------------------
Balance Expense Rate Balance Expense Rate
---------- ------- ----- ---------- -------- ------
Total Earning Assets
LOANS:
Commercial loans $ 786,348 $14,633 7.36% $ 996,347 $ 25,362 10.07%
Commercial Real Estate Loans 142,258 2,895 8.05% 15,947 389 9.65%
Acceptances Discounted 109,132 2,450 8.88% 113,907 2,967 10.30%
Overdraft 3,614 216 23.64% 10,197 339 13.15%
Mortgage loans 1,661 32 7.62% 2,043 41 7.94%
---------- ------- ----- ---------- -------- -----
TOTAL LOANS 1,043,013 20,226 7.67% 1,138,441 29,098 10.11%
---------- ------- ----- ---------- -------- -----
Time Deposit with Banks 28,884 523 7.16% 123,024 2,884 9.27%
Investments 297,746 3,124 4.15% 334,467 6,641 7.85%
Federal funds sold 85,431 751 3.48% 43,327 731 6.67%
---------- ------- ----- ---------- -------- -----
Total Investments and Time Deposit with Banks 412,061 4,398 4.22% 500,818 10,256 8.10%
---------- ------- ----- ---------- -------- -----
Total Interest Earning assets 1,455,074 24,624 6.69% 1,639,259 39,354 9.50%
------- ----- -------- -----
Total non interest earning assets 36,227 67,528
---------- ----------
TOTAL ASSETS $1,491,301 $1,706,787
========== ==========
Interest Bearing Liabilities
DEPOSITS:
NOW and savings accounts $ 20,225 108 2.11% $ 21,153 134 2.51%
Money Market 46,702 476 4.03% 44,320 698 6.23%
Presidential Money Market 66,346 649 3.87% 71,106 1,040 5.79%
Certificate of Deposits (including IRA) 1,137,932 18,370 6.39% 1,177,721 18,834 6.33%
Time Deposits from Banks (IBF) 26,158 198 2.99% 20,128 1,635 32.13%
---------- ------- ----- ---------- -------- -----
TOTAL DEPOSITS 1,297,363 19,801 6.04% 1,334,428 22,341 6.62%
Trust preferred securities 12,650 308 9.74% 12,650 308 9.74%
Securities sold under agreements to repurchase 24 -- 3.41% 107,647 298 1.10%
Federal Funds Purchased -- -- -- 87 1 4.55%
---------- ------- ----- ---------- -------- -----
Total interest bearing liabilities 1,310,037 20,109 6.07% 1,454,812 22,948 6.24%
---------- ------- ----- ---------- -------- -----
Non interest bearing liabilities
Demand Deposits 71,161 73,610
Other Liabilities 30,745 57,844
---------- ----------
Total non interest bearing liabilities 101,906 131,454
---------- ----------
Stockholders' equity 79,358 120,521
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,491,301 $1,706,787
========== ==========
Net Interest income / net interest spread $4,515 0.62% $ 16,406 3.26%
======= ===== ======== =====
Margin
Interest income / interest earning assets 6.69% 9.50%
Interest expense / interest earning assets 5.47% 5.54%
----- -----
Net interest margin 1.23% 3.96%
===== =====
35
PROVISIONS FOR CREDIT LOSSES AND TRANSFER RISK
The Company's provision for credit losses was $15.6 million for the three months
ended September 30, 2001, compared to $32.5 million for the same period of 2000.
The provision in 2001 results from the downgrade of certain loans during the
third quarter, and a change in the methodology followed for the non-graded
portion of the portfolio. The provision in 2000 reflected more significant
downgrades in the 2000 period, compared to 2001 period. See "Credit Quality
Review" for additional discussion of the allowance for loan losses. The
provision for the periods represents the amount management deemed necessary to
maintain the allowance for credit losses at an adequate level. In establishing
the amount of provision for credit losses, management considers various factors,
as discussed under "Credit Quality Review."
For the three months ended September 30, 2001, the Company recovered ATRR of
$14.2 million, compared to a provision for transfer risk of $4.8 million for
the three months ended September 30, 2000. The recovery results primarily from
the sale in the third quarter of 2001 of approximately $32.3 million of assets
subject to a 90% ATRR requirement for cash proceeds of approximately $18.7
million, The gross recovery of approximately $15.5 million was partly offset by
assets that became subject to ATRR provisions in the quarter prior to these
sales. The provision in 2000 reflects the net amount of assets that became
subject to ATRR during the quarter ended September 30, 2000.
NON-INTEREST INCOME
Non-interest income decreased by 19.3 percent to $2.8 million for the three
months ended September 30, 2001 compared to $3.5 million for the same period in
2000. During the third quarter of 2000, the Company recognized gains on
securities transactions of $1.1 million compared to none in 2001, accounting
primarily for the decrease.
The following table sets forth details regarding the components of non-interest
income for the periods indicated.
NON-INTEREST INCOME
(Dollars in thousands)
For the Three Months Ended September 30
------------------------------------------
2001 to 2000
2001 Percent Change 2000
-------- -------------- --------
Trade finance fees and commissions $ 1,513 -19.6% $ 1,882
Customer service fees 349 -3.9% 363
Gain on securities transactions -- -100.0% 1,116
Other 949 665.3% 124
-------- ------ --------
Total non-interest income $ 2,811 -19.3% $ 3,485
======== ====== ========
36
OPERATING EXPENSES
Operating expenses decreased to $12.1 million for the quarter ended September
30, 2001 from $13.2 million for the same period in 2000 a decrease of 8.2
percent. In connection with the sale of a group of Ecuadorian assets, the
Company sold a placement in the amount of $6.0 million for cash proceeds of $3.6
million in the 2001 quarter. This loss in 2001 was offset by litigation reserves
of $3.9 million recorded in the 2000 quarter. No such reserves were required in
2001. Additionally, as a result of supervisory concern, the Bank's risk category
dropped for deposit insurance purposes, resulting in higher deposit insurance
assessments.
OPERATING EXPENSES
(Dollars in thousands)
For the Three Months Ended September 30
---------------------------------------------
2001 to 2000
2001 Percent Change 2000
--------- -------------- ---------
Employee compensation and benefits $ 3,800 8.1% $ 3,514
Occupancy and equipment 1,190 -2.0% 1,217
Other losses and charge offs 2,411 370.9% 512
FDIC Insurance 703 288.4% 181
Legal 1,889 123.0% 847
Litigation reserves -- -100.0% 3,924
Audit and examination 351 64.8% 213
Other operating expenses 1,767 -37.0% 2,801
--------- ------ ---------
Total operating expenses $ 12,111 -8.3% $ 13,209
========= ====== =========
INCOME TAXES
The effective rate of the benefit for income taxes was approximately 42% for the
three months ended September 30, 2000, and no benefit was recorded for the three
months ended September 30, 2001. As a result of continuing operating losses
during the 2001 quarter, realization of the deferred tax asset arising from
these losses is uncertain. A valuation allowance of approximately $2.4 million
was established at September 30, 2001 to fully offset the tax benefit that would
have been recorded had realization of this benefit been determined to be more
likely than not.
37
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Hamilton Bank has been informally advised that the Intervenor of NBK Bank, Lima,
Peru, has instituted civil proceedings in Peru against Hamilton Bank to nullify
an amendment to a credit agreement between Hamilton Bank and NBK Bank. Hamilton
Bank has not been officially notified of this lawsuit in accordance with
Peruvian law. The amendment spread the lien of Hamilton Bank on collateral for
the loan to NBK Bank to related loans. The total amount of the loans at the time
NBK Bank was intervened was $18.2 million. The Intervenor claims the provisions
of the amendment, which is governed by Florida law, providing for automatic
default upon insolvency violated the public policy of Peru and also alleges that
the collateral exceeded the obligations owed to Hamilton Bank. Hamilton Bank
denies the accusations, and local Peruvian counsel is of the opinion that the
provisions of the amendment are permissible under local laws and do not violate
the public policy of Peru.
As previously disclosed, an investigation of the foregoing issues by Peruvian
authorities had been instituted. Hamilton Bank has been advised that the
Peruvian authorities have finished the preliminary investigation and issued a
report that clears Hamilton Bank from any criminal actions in connection with
the assignment.
In April 2001, the Compensation Committee of the Board of Directors of the
Company, after consultation with legal counsel, resolved to terminate the
position of several senior officers under and in accordance with their
employment agreements with the Company. The Compensation Committee decided that
the first such senior officer to be terminated would be a former executive
officer who is also the spouse of the chief executive officer of the Company and
the Bank. In connection with the termination, the Bank paid approximately
$592,000 to the executive pursuant to the terms of the contract regarding
termination without cause. The chief executive officer is not a member of the
Compensation Committee and therefore he did not vote on this matter. Subsequent
to the payment, the OCC advised the Bank that a prior application to the OCC and
the Federal Deposit Insurance Corporation ("FDIC") was required due to the
Bank's troubled condition. Because no such prior application was made to and
approved by the OCC and the FDIC, the OCC and the FDIC further advised the Bank
that the severance payment was prohibited under Federal banking regulations. The
Bank subsequently made such an application for the above mentioned officers,
which was denied by the OCC and the FDIC in September 2001. The OCC and the FDIC
have directed the Board of Directors of the Bank to cause restitution to be made
to the Bank. The Board is negotiating with the former executive officer to cause
restitution to be made to the Bank, but there is no assurance that such
negotiations will be successful. If unsuccessful, the OCC has advised the Board
that it expects the Board to take appropriate actions to cause restitution to be
made. At this time, management is unable to predict the ultimate resolution of
this matter or the impact this matter will have on the Company or the Bank.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
On October 17, 2001, the Company filed a report on Form 8-K, which was
subsequently amended on October 19, 2001 on a Form 8-K/A, regarding the
resignation of Deloitte & Touche LLP as its certifying accountant on October 10,
2001.
On November 1, 2001, the Company filed a report on Form 8-K regarding the
appointment by the Company's Audit Committee of the Board of Directors of
Kaufman, Rossin & Co. as the Company's certifying accountant for the year ending
December 31, 2001, effective October 31, 2001.
EXHIBIT NO. DESCRIPTION
11. Calculation of Loss per share
38
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 19, 2001 Hamilton Bancorp Inc.
/s/ J. Carlos Bernace
----------------------------------------
J. Carlos Bernace
Executive Vice President
/s/ Lucious T. Harris
----------------------------------------
Lucious T. Harris
Executive Vice President and
Chief Financial Officer
39